China’s economic judders bring questions – and opportunity

29 Aug 2015 | Author: | No comments yet »

After Two Weeks of Market Turmoil, What’s Changed? Not Much.

NEW YORK: A volatile ride for global markets this week ended calmly on Friday even as lingering worries over Chinese economic growth and the Federal Reserve’s plans to raise interest rates weighed on stocks, but oil rebounded sharply for a second day. After a dizzying two weeks that saw a rapid plunge and rebound in equity prices, investors are looking forward to a week of economic data that may provide clarity on the likelihood of a near-term U.S. interest rate hike and help tamp down the market’s recent wild swings.Anyone trying to design an event to bring Xi Jinping’s China back to Earth couldn’t have engineered something much more elegant than the turmoil in China’s financial markets and the resulting global aftershocks.The August jobs report will be the highlight of next week’s economic calendar as investors and Federal Reserve policy makers look for sustained strength in U.S. labor markets.

China’s recent stock-market plunge was a “healthy” price adjustment and the nation’s economy still has strong growth potential, especially if the government enacts targeted reforms and stimulus efforts, said a former academic adviser to the People’s Bank of China. On Aug 11, an unexpected 1.9% devaluation of the yuan fuelled fears about the outlook of the Chinese economy, setting off falls in commodity prices and emerging market (EM) currencies and equities over an extended period. Due out Friday, the labor report will undoubtedly play a key role in helping members of the central bank’s policy-setting Federal Open Market Committee determine whether to move ahead with a rate hike at their September meeting or delay until later in the year or possibly into 2016. A goal for economic growth of 7 percent “is still in my view what policy makers will and should aim for,” Li Daokui, a professor at Tsinghua University, said in a luncheon address on Friday at the Kansas City Federal Reserve’s policy conference in Jackson Hole, Wyoming. Stock markets in Europe and the United States wobbled and then fell sharply, culminating in the 1,000 points intra-day drop in the Dow Jones Industrial Index (Dow) on Black Monday (Aug 24).

Yet the jolt may have been just large enough to change the country’s underlying bargain between ruler and ruled—and by doing so, to temper Beijing’s current tendency toward arrogance, rigidity, belligerence and diplomatic hectoring. Li said Chinese officials have room to further cut interest rates and lower required reserve ratios for banks in an effort to boost lending and the economy. Decision makers in China “are worried for both economic and political reasons,” Tsinghua University economist Li Daokui said Friday in a speech at the Federal Reserve Bank of Kansas City’s annual economic symposium. Global stock markets were stung by severe swings in recent weeks, stoked by concerns that a slowdown in China’s economy may be more harsh than anticipated.

Copper, aluminium, zinc and lead prices hit five to six-year lows; oil futures fell below US$40 a barrel; and the ringgit dropped to its lowest level since the Asian crisis in 1998. If the week’s tumult has reminded Americans nervously eyeing their retirement funds of the interconnectedness of the global economy, it may also serve to remind today’s proud Chinese leaders that they too exist in a larger context—that they need their neighbors, that they need the U.S. and that they might need to become a little more accommodating. But global markets have been chaotic during the past couple of weeks, responding mostly to a sharp selloff in the Chinese stock market and signs that China’s growth may be slowing. The PBOC cut its one-year lending rate this week by 25 basis points to 4.6 percent and lowered banks’ reserve-requirement ratio by 50 basis points to 18 percent. “Some people argue the natural rate of growth will come down to lower than 6 percent,” largely because of a growing shortage of labor, he said. “I do not fully agree with this analysis,” because it doesn’t take into account that workers will gain skills and education, making them more productive. Due to “the last round of the stock-market selloff and because of the international attention to Chinese economic issues,” he added, “I really think there’s a very high chance…that a mini-stimulus package [will] be put together.” Mr.

The Fed is waiting to see how data and markets unfold over the coming weeks before deciding whether to raise rates at its meeting in mid-September, Vice Chair Stanley Fischer told CNBC. Xi has seemed pleased by his ability to seize and use power—to have China’s weaker neighbors genuflect and have the world respond more compliantly. Elements could include lowering long-term financing costs and the implementation of previously announced reforms for state-owned enterprises, he said. The disparity between global turmoil and domestic economic health has been duly noted by a number of influential Fed members, several of whom made it clear last week that despite the market gyrations a September rate hike is still on the table.

Traders in futures markets that bet on rate increases boosted September’s odds after his words. “There is a narrative out there that Yellen’s Fed is looking for a reason to delay the rate hike; I don’t think that is necessarily the case,” said Brad McMillan, chief investment officer for Commonwealth Financial in Waltham, Massachusetts. China – still the world’s fastest growing big economy, is in the midst of a difficult transition involving market reforms that’s not working according to theory. A society that had grown accustomed to dismissing anyone it didn’t like—including the U.S.—has been rattled by a marketplace that doesn’t know what obedience is. Investors will also be perusing the Fed’s Beige Book, which provides anecdotal accounts of the health of the Fed’s 12 regional areas and is out Wednesday.

After a stronger-than-expected revision to second quarter gross domestic product and solid durable goods figures, another run of strong data next week could bolster the case for a rate increase next month. Also, market movements can themselves generate economic distress by destroying wealth or interfering with companies’ or households’ ability to raise funds. But traders also are also mindful of the fact that the Chinese slowdown could hit U.S. companies and their shares disproportionately in the second half of the year, with luxury goods companies and industrials among the groups paying a price. The free fall in the stock markets has been especially unnerving in a society over which the party has long pretended to ride herd—and has heretofore done well enough at creating economic growth that it had come to seem invincible and omnipotent. Thomson Reuters data shows third-quarter earnings expectations have dropped 6.4 percent for the industrial sector and 8.8 percent for the materials sector since July 1.

Should analysts continue to downgrade their expectations for third- and fourth-quarter earnings in those sectors or more broadly, that could make stocks more expensive, even after the recent selloff. “It is more important to the U.S. whether or not GM and Ford can sell cars there,” said Kim Forrest, senior equity research analyst, Fort Pitt Capital Group in Pittsburgh. German bond yields edged lower, defying the sudden surge in oil, as data showed consumer prices in Europe’s biggest economy had been weighed down by falling energy costs.

Enjoying torrid two-figure growth rates, China boasted urban skylines bristling with cranes and towering high-rise buildings while its countryside became laced with freeways, high-speed rail systems and wireless telecom networks. A year and a half ago, the composite index of China’s once-placid stock markets—one in Shanghai where 831 companies are listed and one in Shenzhen listing some 1,700—started its rapid and stratospheric climb, as if it had suddenly grown embarrassed by its relative languor. Morgan, it would trim 0.25 percentage points off the growth of consumer spending over each of the next two years, roughly equal to the expected boost from lower gasoline prices. This puts a squeeze on EMs: (i) from capital outflows to capture higher yielding US assets; and (ii) from rising currency risks in servicing EM’s US$1.3 trillion of US dollar debt raised since 2010. The party’s own mouthpiece, the People’s Daily, exhorted “the broad masses” to join the feeding frenzy, claiming that China’s bull market was just beginning.

Louis, which melds stock market indicators with a range of others covering bond and money markets, has ticked up but remains below normal. (One trouble spot to watch: problems pricing and trading exchange-traded funds, a major channel for both stock and bond strategies.) What about the rest of the world? But alternative measures, such as industrial production, exaggerate the slowdown because China’s economy is shifting to services, which are more labor intensive. When China’s stock markets finally started their hyperactive rise, one more cog in this well-oiled juggernaut of progress just seemed to be kicking into gear. Until recently, the yuan had tracked US dollar’s ascent despite China’s slowing economy – indeed, the yuan had appreciated by more than 10% against its trade weighted basket since 2014. Xi does) or “socialism with Chinese characteristics” (as the party likes), but many Chinese were only too glad to proudly embrace this new vision of rejuvenation and prowess.

Subsequent events have kept the yuan value in line with those of its peers – and remains part of its reform exercise, not a shift in exchange rate policy. Meanwhile, here was China, a country that President Bill Clinton once consigned to “the wrong side of history,” making a glorious end run around the verities of all the vaunted Western development theorists. The Dow was in correction-mode on the previous Friday, falling 10% from its previous peak following its worst week since 2011 when US sovereign debt rating was downgraded. In 2008-09, as the collapse of Lehman Brothers sent the U.S. into the worst financial crisis since the Depression, China again glided through unscathed.

After years of experimenting with what Deng once called “crossing the river by feeling the way over the stones,” China had seemingly arrived safely on the other side—and built not just a Chinese model but an economic perpetual-motion machine that had the added virtue of being patented in China rather than abroad. Some wondered if the blush wasn’t off the American rose—if the future might soon be claimed not by U.S. entrepreneurs but by Leninist capitalists. “The Chinese model has transcended the dichotomy between socialism and capitalism,” proclaimed Li Xiguang, a professor of media at Beijing’s Tsinghua University. “It has broken down the universe of discourse of the old market style of economy and proven that there is no singe narrative that is suitable for the whole world.” Mr. Largely because outsiders were divided on whether the move was, as the PBOC claimed, a genuine effort to align the currency with market forces, or a panicked response by Chinese political leaders to an economy slowing more quickly than they realized. Xi himself has sounded similar notes. “One part of the now long-standing Chinese leadership critique of Western-style democracy is that it is prone to paralysis and gridlock and ultimately governmental weakness,” he said in Sept. 2014 in Beijing’s Great Hall of the People.

China, says Gavekal, is “pursuing an opportunistic agenda driven largely by nationalist political considerations….This means that Chinese policy decisions are becoming less predictable, and that the potential for conflict between political goals and economic fundamentals is increasing.” The writing has long been on the wall. This confidence in the strength of the China model—and the supposed weakness of its Western competitors—has reshaped the way Beijing relates to the world. Its new confidence in its wealth and power has been matched by an increasingly unyielding and aggressive posture abroad that has been on most vivid display in its maritime disputes in the South and East China seas. China has claimed a protrusion hanging down from Hainan Island into the South China Sea like a giant cow’s udder, along the Vietnamese and Philippine coastlines all the way to Indonesia. The audacity of insisting that all the contested atolls and islands in the region are sovereign Chinese territory—and the uncompromising attitude with which Chinese officials pressed the claim—marked a more aggressive phase in Chinese foreign policy.

All these reflect intense weakness in commodities and EMs as well as concerns about China and overall global growth, and rising risk of yet another financial crisis. A few analysts—mostly notably David Shambaugh, a George Washington University professor, in these pages in March—have warned that the center of this new Chinese proposition cannot hold.

Shambaugh argued, China was plagued by unresolved contradictions and headed for “a breaking point.” Other China specialists strenuously disagreed. As a result of being squeezed, policymakers in many EM nations are struggling to cope with several factors beyond their control that have, when combined and in conjunction with destabilising “host” social-political issues, hit their currencies hard.

And in the remote event that a few rate increases trigger market chaos and set back growth, neither the Fed, nor its global counterparts, are well equipped to respond. The plunge was all the more unnerving because it belied the party leadership’s conceit that their superior formula of governance could safely guide the economy through just such cyclical shocks. Still foreigners continue to hold about 45% of the government’s debt, while private foreign currency denominated borrowing (mainly in US dollar) today accounts for about 24% of GDP. This pretension had not only helped create a mythology of can-do omnipotence and invincibility around party leaders but also helped silence foreign critics of the slow pace of economic reform and the complete absence of political reform.

At the end of the day, the combination of a weakening currency and the absence of firm, predictable political stability is affecting everybody, including meeting the ultimate aim of public policy to raise living standards. And on Aug. 12, a chemical warehouse serving the port city of Tianjin blew up in a devastating explosion that incinerated whole lots full of export vehicles, demolished thousands of apartments, killed some 140 people and spewed untold quantities of toxic chemicals into densely populated neighborhoods.

For China’s leaders, the most profound problem with this string of events isn’t simply the monetary loss or the body count but the overall psychological effect. Moreover, because the party leadership and central government purport to control so many aspects of Chinese life—from economics and financial markets to culture and politics—they get blamed first whenever anything goes awry. Until the market correction settles down, EM currencies stabilise, and the real economy shows clear signs of health, the stench of crisis will remain. > Stay cool: US stocks are not really cheap even after Black Monday, trading at 24.9 times average long-term earnings according to Nobel Laureate Yale Profesor Shiller (down from 27 times in early 2015). > What’s going to happen?: Market pundit talk is just that – talk. Former banker, Harvard educated economist and British Chartered Scientist Lin is the author of “The Global Economy in Turbulent Times” (Wiley, 2015). In the China equation, a crack in the edifice of trust can corrode confidence in party rule and threaten the legitimacy of the state—one of the leadership’s biggest fears.

Xi, who has acquired far more power than any other recent leader—and, in the process, gained a reputation as an implacable, no-nonsense, if enigmatic ruler. Sometimes a crisis that shocks, even humbles, but doesn’t completely upend can catalyze a crucial moment of reflection that leads to reappraisal and even change. Xi and his comrades to recognize that China can no longer be such an island—that China cannot succeed in isolation, much less by antagonizing most of its neighbors and the U.S. As large, dynamic and successful as China has become, it still exists in a global context—and remains vulnerable to myriad forces beyond the party’s control. If the alarms over the past few months presage such a revelation in Beijing, it would not only enhance China’s stability but its soft power and historic quest for global respect.

But it also offers both countries a chance to work together on one of the greatest challenges of the century: forming a more effective partnership to tackle global climate change. But if China should take any larger message away from its near-death tangle with its own financial markets, it is that neither country—nor the world at large—has much hope of dealing with the century’s shared problems if Washington and Beijing cannot find more common cause.

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