Thursday, August 11, 2016

Flashback: "Two Prisms for Looking at China's Problems"

Introduction:  The Chinese economy began to show signs of a downtrend in the business cycle long before the current troubles.  Instead of welcoming the adjustments, Chinese policy makers opted for more Keynesian stimulus.  Did lower interest rates, more artificial credit, and more fiscal spending delay the adjust process?  Yes.  Did it eliminate the need to adjust?  No.
The New York Times - August 11, 2012 - Tyler Cowen - "Two Prisms for Looking at China's Problems"

China is confronting some serious economic problems, and how Beijing does — or doesn’t — respond to them could bend the course of the global economy.

First, China’s real estate bubble is deflating. But its economy also seems to be suffering from what we economists call excess capacity — an overinvestment in capital goods, whether in factories, retail stores or infrastructure. So what now? The answer depends in part on your school of economic thinking.

Keynesian economics holds that aggregate demand — the sum of all consumption, investment, government spending and net exports — drives stability, and that government can and should help in difficult times. But the Austrian perspective, developed by the Austrian economists Ludwig von Mises and Friedrich A. Hayek, and championed today by many libertarians and conservatives, emphasizes how government policy often makes things worse, not better.

Economists of all stripes agree that China may be in for a spill. John Maynard Keynes emphasized back in the 1930s the dangers of speculative bubbles, and China certainly seems to have had one in its property market.

Keynesians would argue that Beijing has the tools to stoke aggregate demand. It could, for example, adjust interest rates and bank reserve requirements, instruct state-owned banks to maintain lending, or deploy some of its $3 trillion in foreign exchange reserves. The government also appears to have many shovel-ready construction and infrastructure projects that could help the economy glide to a soft landing and then bounce back.

The Austrian perspective introduces some scarier considerations. China has been investing 40 percent to 50 percent of its national income. But it is hard to invest so much money wisely, particularly in an environment of economic favoritism. And this rate of investment is artificially high to begin with.

Beijing is often accused of manipulating the value of its currency, the renminbi, to subsidize its manufacturing. The government also funnels domestic savings into the national banking system and grants subsidies to politically favored businesses, and it seems obsessed with building infrastructure. All of this tips the economy in very particular directions.

The Austrian approach raises the possibility that there is no way for China to make good on enough of its oversubsidized investments. At first, they create lots of jobs and revenue, but as the business cycle proceeds, new marginal investments become less valuable and more prone to allocation by corruption. The giddy booms of earlier times wear off, and suddenly not every decision seems wise. The combination can lead to an economic crackup — not because aggregate demand is too low, but because the economy has been producing the wrong mix of goods and services.

To keep its investments in business, the Chinese government will almost certainly continue to use political means, like propping up ailing companies with credit from state-owned banks. But whether or not those companies survive, the investments themselves have been wasteful, and that will eventually damage the economy. In the Austrian perspective, the government has less ability to set things right than in Keynesian theories.

Furthermore, it is becoming harder to stimulate the Chinese economy effectively. The flow of funds out of China has accelerated recently, and the trend may continue as the government liberalizes capital markets and as Chinese businesses become more international and learn how to game the system. Again, reflecting a core theme of Austrian economics, market forces are overturning or refusing to validate the state-preferred pattern of investments.

For Western economies, the Keynesian view is much more popular than the Austrian view among mainstream economists. The Austrian view has a hard time explaining how so many investors can be fooled into so much malinvestment, especially given the traditional Austrian perspective that markets are fairly effective in allocating resources. But China has had such an extreme and pronounced artificial subsidization of investment that the Austrian perspective may apply there to a greater degree.

The optimistic view is that Chinese excess capacity and overbuilding are manageable — that the current overextensions of investment will be propped up, but they won’t have to be propped up for long. In this view, the Chinese economy will fairly soon grow rather naturally into supporting its current capital structure, and its downturns will be mere hiccups, not busts.

The pessimistic view is that the problems are so large that the government’s attempts to prop up its investments with further subsidies could so limit consumption, and so distort resource allocation, that the Chinese economy will stagnate. In this view, the political means for allocating investment would grow to dominate market forces, the proposed “economic rebalancing” of the Chinese economy toward domestic consumption would become a distant memory, and China would have an even tougher time opening its capital markets and liberalizing its economy. Given that China already faces competition from nations where wages are lower, and that its population is aging, the country might not return to its previous growth track.

The jury is out. But to my eye, we may well find a significant and lasting disruption, closer to what the Austrian theory would predict. Consider a broader historical perspective: How often in world history have countries enjoyed 30-plus years of extremely rapid growth without a major economic tumble somewhere along the way? One can be optimistic about China for the long term and still be fearful for the next turn in its business cycle.

In any case, China has surprised the world many times before — and is likely to surprise it again.

Sunday, January 31, 2016

Apparently, the China Century Already Ended.

Back in June, 2015, I asked the question:  "Will the China Century end in 2019?"  That article analyzed International Monetary Fund projections to point out in that year China will contribute less nominal gross domestic product than the United States.

According to Bloomberg, this already happened in 2015.
For the first time in almost a decade, China has lost ground in catching up with the U.S. economy, when output is measured in dollars.
U.S. gross domestic product increased $590 billion in 2015 from a year earlier, according to data released Friday. China’s economy, while reporting 6.9 percent growth for the year, added $439 billion, as a weaker yuan sapped the value of output gains in dollar terms, according to data compiled by Bloomberg. [Read more...]

Monday, November 23, 2015

Bloomberg: "Devaluation Watch May Force China to Pay Premium on Dim Sum Debt"

Fion Li.  Bloomberg.  November 22nd, 2015.
China is set to pay more to sell sovereign bonds in Hong Kong than in the onshore market for the first time, as investors brace for the possibility of another yuan devaluation.

The Ministry of Finance will sell 14 billion yuan ($2.2 billion) of Dim Sum notes in the city this week, including 2 billion yuan to individuals. The yield on offshore yuan securities due 2020 was 3.39 percent on Nov. 20, 25 basis points higher than debt of the same maturity in Shanghai, suggesting the government will have to pay more to borrow outside of the country.

Sunday, November 22, 2015

2015-10 Relative Price Trends


In October, consumer prices increased by 1.3% from the same month last year, and purchaser prices decreased -6.9% over the same period.  The rate for consumer prices was the lowest increase in five months, and the rate for purchaser prices was the lowest since 2009.  Based on this metric, the Chinese business cycle is in its 47th month of contraction.

Sunday, November 8, 2015

2015-10 Stock Market Valuation


The Chinese stock market bounced back in October to 0.28 gold ounces, up 0.04 ounces since the end of September.  It was primarily valuation driven, because the price-to-earnings ratio increased faster than the gold price.  Despite being down from the peak, the index is still up 46% over the last 12 months, and has seen positive growth for 34 consecutive months.

Sunday, November 1, 2015

2015-10 Relative Equity Performance


In October, the exchange traded fund tracking the consumer goods sector, CHIQ, fell -0.58% over the trailing twelve months.  The materials sector equivalent, CHIM, fell -10.79% over the same period.  This is the second month in a row that CHIQ has outperformed CHIM, and is close to being positive over the trailing twelve months.  This trend should continue if the cost of raw materials continue to fall at an accelerating rate while consumer prices are essentially flat.

Sunday, October 25, 2015

2015-09 Interest Rate Trends

In September, the overnight interbank rate and private lending rate saw a continuation of the previous divergence in rates.


The Shanghai Interbank Offer Rate ended September at 1.99%, up 19 basis points from August.  Despite central bank policy, nominal rates have continued to rise over the last five months, although this September was still 57 basis points below the trailing average for September of 2.56%.


The Wenzhou Comprehensive Index ended September at 19.20%, down one basis point from August.  September's rate was 71 basis points tlower than the trailing average for Septembers.

According to Reuters, the situation for smaller enterprises is only getting worse:
The central bank has cut official lending rates five times since November by a total of 1.4 percentage points to 4.6 percent. But instead of falling, lending rates to SMEs have risen by 2 percentage points as willing lenders become scarce.

The Wenzhou index, which tracks private lending, shows the rate for 1 year or more has risen to 18 percent from around 16 percent in November. In April, rates were as high as 24 percent.

The state-dominated banking sector has become more selective in issuing loans in general, as non-performing loans increase in the economic slowdown. China's big-four banks all reported a rise in non-performing loans in the latest quarter.

China's economy is heading for its weakest growth in 25 years, and a recent run of poor data suggests it is struggling to meet its 7 percent target for 2015.

So only the brave are stepping in to lend to its most vulnerable firms - small, medium and micro businesses. That is reflected in central bank figures showing that while overall lending in China has risen, new loans to small businesses fell in the first half of the calendar year compared with the same period in 2014.