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:
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- 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.
Nice Site layout for your blog. I am looking forward to reading more from you.
Tom Humes
… 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.
Logical behaviour in times of massive currency destruction.
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.
Overcapacities – in terms of production facilities (corporate investment), housing (household investment) and bridge to somewhere but with no financial sense (now at state level) – are the obvious consequence of interest rate and money market manipulations.
Being an Austrian economist helps here. But this will end badly I alas meany REALLY bad. Thank you for the fair and courageous feedback anyway.
… 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.
Logical behaviour in times of massive currency destruction.
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.
Overcapacities – in terms of production facilities (corporate investment), housing (household investment) and bridge to somewhere but with no financial sense (now at state level) – are the obvious consequence of interest rate and money market manipulations.
Being an Austrian economist helps here. But this will end badly I alas meany REALLY bad. Thank you for the fair and courageous feedback anyway.
Sorry, forgot to add great post! Can’t wait to see your next post!
Hi Michael,
Thanks for your post. I entirely agree with Daniel de Paris with your “fair and courageous feedback”.
Although it´s possible to read and comment your last post using IE the other parts of your blog are unacessible. MikeG suggestion was great. With Firefox the access to the blog is OK.
So, China is being able to impose a favorable market share shift on other export countries, not considering obviously oil exporters. Who is on the other side? Japan, Germany, other Asian countries, India, Brazil, and other emerging economies.
I know you believe that China has made through practice an option for capitalism with no way back. But, what about if Hu´s recent words are for real, and they do have a strategic aim? If that is so, we could be seeing a political struggle were the other side is formed mainly by countries that lost the WWII and still have little political and military force. Obviously this would lead, as you say, in a second moment, to a dramatic decrease in the world´s already depressed trade level that would affect China also but, at the same time, would severely hit the already weakened US and EU economies.
I would remember that it has always been part of the ideology the necessity of a capitalist stage. If that is so, at some point wouldn´t they come up with heterodox (from the dominant´s economic theory point of view) solutions, like a massive transference of resources directly to the people, similar to what Brazil is doing in a limited way?
Regards,
Christopher.
Professor Pettis: It is great to see that you have unblocked your comments section !!
Most of the recent data support your analysis and keen insights, although I still find them a tad pessimistic.
I agree with Daniel de Paris that the run up in commodity stockpiling and prices is a logical consequence of huge Central Bank money creation.
Andy Xie’s analysis (in Caijing) of how Central Banks are creating a new bubble to offset the bust of the last one is spot on.
Central banks are playing a ‘high risk’ poker game to save the financial system by “growing out” of of NPL problems. This can only lead to more inflation to erode debt loads and a depreciation of the US dollar. This is why Central Banks are talking tough about inflation and exit strategies while trying to target zero or negative real interest rates.
The problem is that this bubbles can lead a life of its own — and we have no idea when and what will trigger bond holders to factor in higher inflation. It is indeed very strange that rising oil and gold prices have had so little impact on inflation expectations measured by the spread between indexed vs. unindexed Treasury bonds. Is this due to the world savings glut?
Great to see your comments section back in operation ! regards James
daniel:
Logical behaviour in times of massive currency destruction.
??
en période de déflation ne vaut-il pas mieux stocker du cash que des matières premières ?
in deflation periods, is’nt cash better than commodities ?
Michael – excellent work as always. You’ve become my (& others) goto address for understanding the opaque realities of the China markets and economy. From previous discussions you know I whole-heartedly endorse and concur with your arguments (that’s not entirely fair since I learned it from you though
). Given that Hu, et.al. have acknowledged a need to shift the structure of the Chinese economy but are doing something vastly different plus the recent G-20 pronouncements, et.al. on the subject this looks like a major problem.
It also raises a lot of mythologies and shibboleths up to be punctured. The other side of this coin is a structural increase in US net exports brought about by a shift from dissavings to savings. The consequences of these structural shifts will be severe, starting with the growing trade tensions you focus on, imho. The immediate consequences for so many of the headline investment strategies are likely to be unpleasant as well, if both are positions are right (and bearing in mind they are mirrors of one another):
From Mythologies to Realities: Economy, Employment, Credit & Trade
http://llinlithgow.com/bizzX/2009/10/from_mythologies_to_realities.html
is my take on how all the various factors play back and forth which I’m posting here instead of sending on so others can chime in.
Michael, I have been awaiting your post. But, I disagree with these folks. There won’t be any inflation. What there has been is rampant speculation. What there will be is no exit from the accumulated speculation. I suspect the NPL’s you are mentioning will be worldwide.
Agree with Paris … I remember back in the 80s when Chinese, given limited investment options, would buy 5-10 refrigerators as “speculative investments” (to combat rampant inflation).
Great post. I agree with most of the sentiment especially the strange stockpiling behavior. The Chinese economy is faced with massive deflationary pressures contrary to what most of the other comments on here seem to suggest. Why else would household income and purchasing power decrease while money supply increased. Especially in a labor intensive economy. Overinvestment can only imply deflationary pressure with firms flooding markets with goods that will only get cheaper. Which in my mind will further exacerbate the trade pressures that you see coming. The only question that remains is what jingoistic cards will Hu and Wen play to help them stall while they wait for a “miracle” global recovery.
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,
Maybe it’s looking on the bright side – but at least the squeeze on the very definition of loose credit is real, not fictional. What is really worrying is the selling of the loans – did no one remember the whole subprime mess? With the primitive state of regulations, one shudders to think of what mess could emerge.
BTW, welcome back to accessible land mr pettis!
Sorry, not equating those loans to subprime loans but rather the whole mechanism of loan syndication and the fact that if investor groups are involved, just how much information do they have and what level of comprehension is there with regards to the loan structures and risk factors.
“It seems that there may be another explanation, and that is stockpiling by private investors.”
The following dish, is being prepared for overcapacity seating at a banquet where fewer guests can afford to attend:
“Chinese Stim’d Copper One Tons”
China’s Pig Farmers Amass Copper, Nickel, Sucden Says
http://www.bloomberg.com/apps/news?pid=20601109&sid=a1B_ZBQfii8Q
Dynamics like this will ultimately come to an end trigger even more painful implosive deflation than was being mitigated by the stimuli, and that will require direct destruction of assets, production capacity and ultimately civil and international war.
The only way out of the race to the bottom on workers’ compensation is a transnationally coordinated rise of global wages through a global minimum wage or convergence toward a World Wide Wage system.
Just as in the 1930′s, the capitalist system as whole needs a militant global working class movement to force the global aggregate demand to be increased through a World Wide Wage, against the separate necessity and will of each capitalist.
This is a manifestation of a fundamental contradiction.
Based on your assessment it would appear that China has been following the Japanese model quite closely, minus the quality control philosophy. Starving domestic consumption growth to subsidize an inefficient, environment-destroying export sector is a serious mistake.
Saying that the US consumer switching to savings will cause trade tensions makes no sense to me. Is China’s leadership to become angry because we in the US are buying less of China’s production? US consumers would be prudent to reduce their debts and save more.
There is much talk about rising “protectionism” but what is the yuan peg to the dollar if not a highly protectionist policy? China’s leadership can make few non-hypocritical statements toward foreign countries regarding protectionism and trade policy.
Michael, I haven’t heard of any loan sales as yet: they’re not offering them to people abroad and even for onshore vehicles there doesn’t seem to be much demand. They do seem to be pushing more CNY issues onshore but the bond market is opening up painfully slowly, if only because there is no demand for the debt. If government bond issues fail every so often how can they expect people to buy SOE debt at PBOC bills + 70 when creditor protection is so bad there? I think the BOCOM analyst is expressing more a desire to sell than completed sales along the lines of Q2 2008 “Merill Lynch is actively selling its asset backed structured credit positions”.
michael
I read your blogs with great interest having first visited China in 1993 and since then spending 2-3 months each year in the country, until 3 years ago spending most of my time visiting factories all over th e country.
Your note about speculative buying of commodities resonates with my own knowledge which is that of copper.
1. Around 40% of all copper cathode imports are owned by foreigners – a means of trying to tighten up the world market since these tonnages are warehoused outside the reporting system and are not sold. As of mid year it amounted to about 700kt and must now be 900-1000kt.
2. Private sector companies, such as amongst toy makers and textile cos are holding at least 100kt ‘as a store of value’.
3. Chinese individuals and institutions have bought copper for the same reason. How much difficult to judge but probably in total 300-500kt.
4. From my chats industry itself is ebing cautious having been burnt last year.
5. I concluded from my last trip in June that China was engaged in ne huge speculative fever embracing equity, real estate and commodity markets, fueled by probably two-thirds of the fiscal stimulus and bank lending not going into the real economy but into speculative hands.
At some point in the fiture this will all blow up!
best simon
Mannfm11 and Sean Cheang: as regards the dangers of deflation versus inflation — you might distinguish between big surplus (China, Germany, Japan) versus big defict countries (USA, UK, etc).
What is obviously needed is higher consumption in the former and higher savings in the latter. But as surplus countries resist appreciation they force the defict countries to inflate away their problems or face painful bankruptcies and chronic high unemployment.
The outcome is uncertain, but as the deficit countries have more political muscle — political choice favours — higher world inflation and stagflation? regards James
A couple of points:
1) Loans are still being provided at a high rate by small banks. Doesn’t this suggest that real demand exists? While the big 4′s behaviour can be put down to political pressure, does that still apply to all the local banks, which presumably don’t benefit from the same generous bail-out packages when things go wrong?
2) This stockpiling is going on and on and on. People have been talking about it for months now. With the world economy looking better, doesn’t it now make sense to say that it was a rational choice, purchasing during a period of low prices for later use?
Pettis seems to jump on every instance of investment-like behaviour in China and call it a problem. But the high-investment model has been hugely successful so far, while other countries around the world have been disinvesting. China’s investment is likely to pay off in terms of future growth potential.
Here is a very different take on the inevitable success of overinvestment:
BEIJING (MNI) – China’s government outlined plans to crack down on industrial overcapacity Monday with a raft of measures including restrictions on debt and equity financing. The measures outlined by the National Development and Reform Commission affect industries including steel, cement, glass and windpower equipment.
They follow earlier government pledges to take action to clamp down on overcapacity which officials fear could lead to collapsing profit margins, factory closures, rising bad loans and unemployment. The planning agency said Monday that financial institutions are forbidden from granting loans to any projects that fail to meet Beijing’s industrial policies.
Projects or companies involved in projects that violate industrial policies are not allowed to raise funds through the issuance of corporate bonds or short- and medium-term corporate paper and are also banned from raising funds via initial public offerings or through additional sales of shares.
Local governments are also not allowed to use fiscal funds to fund projects in industries in overcapacity.
Phil, the smaller citty and cooperative banks are subject to even more pressure from local and municipal governments than the Big 4 banks. They are much more dependent on politial patronage and favor than the big banks, who are heavily controlled but still have some independent clout.
Phil Hand
The smaller banks enjoy protection from Local governments (and possibly even the central government if there is a feared knock on effect.) Of course they also suffer much more from pressure at the local government level. I would say that whilst a failure is more possible at a local level, they still enjoy a great deal of protection. On one hand, the withdrawl of the big 5 from lending could be explained as the result of central government pressure, but local level developments and needs still trump it all.
Also some argue that the big banks had a favourable position early on – they could compete for larger projects and were better capitalized (mostly) to expand lending. The smaller banks have been squeezed out somewhat, and some spent the beginning of the year raising their coverage ratios and capital levels.
Generally speaking we think that the Central government has decided that it is time to start thinking (but not too hard) about limiting liquidity and consolidating the position, there have been some tentative moves in this direction. In China it is never easy to get the local governments to heel though – Hu Jintao has been trying to recentralize control since coming in.
Thanks Daniel. I don’t consider myself a hard-core Austrian but I do not believe that a country with the highest level of investment in history – much of which was seriously misallocated and only “viable” thanks to enormous interest and other subsidies – can substantially increase investment with almost no quality control and not be expected to pay some cost. The questions for me are only the timing of the “repayment” and whether the economy and the major balance sheets have imbedded in them the kinds of pro-cyclical mechanisms that can cause huge jumps in volatility.
Christopher, a transfer of resources fro0m the state and investment sectors to households is almost certainly necessary and almost equally certainly very hard to do politically since it would involve a substantial transfer of power. I am not sure how that would likely occur, but I think eventually it will.
Mannfm and Sean, the question of whether monetary and credit expansion will lead to inflation or to overcapacity and deflation is one that I am still having trouble resolving. It is easy to make arguments either way, but none so far are convincing, at least as far as I can see.
Thanks Judy. Good to see you back.
Great article, Pangea, and in a way pretty funny. I will refer to it on my next post. I do think we need wages to rise in a number of countries relative to national income.
Rosethorn, yes, and comparisons with Japan are not confidence boosting.
Thanks Simon. I wish your comments didn’t worry me, but they do.
Phil, I am not sure why we would assume political pressure on big banks is greater than on small banks. Probably the opposite is true. What it suggests to me is that the CBRC is more worried about the impact of the Big Four on systemic risk. And stockpiling may be a rational choice, but there are many “rational” scenarios. Non-recourse debt-funded stockpiling of any asset is always rational, as long as you believe that the possibility of a collapse is less than 100%. It also makes rational sense if you are worried about holding alternative assets. Finally I am not sure why you suggest that the high investment model has always made sense. It has often made sense during periods of surging consumption and rising trade, and often gets large economies into trouble during secular periods of contracting consumption and declining trade.
I follow your blog for quite a while now and this last article is really good.
Just one question. Could you explain what “the net paydown of bill financing is?
thanks
Michael, Commodities import is a rather small part of the total import of China. It would be interesting to see the details of the two items which are not detailed in the Chinese Customs’s report: “electrical and mechanical products” and “high-tech products”. Those items have a much bigger effect on the total import than commodities (the lower prices of commodities somewhat offset the higher volumes).
This article is exactly on par with everything I am watching too….IMHO this is just one big bubble that can’t end well at all. The world is seeing this demand for Copper, etc and is under a belief of Global Growth and have increased production to meet this new demand, but as we know, it’s speculation and stockpiles and no demand. Any thoughts on the Sept 28 Chinese Bond issues?
Interesting.
The stocking of the industrial materials as an investment,and the buying of the yüan is completly opposite strategies.
If the yüan will be weaker,then the winner be the peasanat.
But who will be the winner if the yüan will be stronger?
Mike,
I think you’re missing promising comments such as this:
The Intel chief said demand from China, and consumers, was key to getting the company through the downturn. “Thank God for China. They bouyed, certainly our company, through the depths of this thing,” said Mr. Otellini.
My thoughts on deflation have been strongly shaped by an old but interesting paper by Lau, Qian and Roland title Reform without Losers: An Interpretation of China’s Dual- Track Approach to Transition. I would be very interested in hearing what you think about the paper and its results.
Thanks for the thoughts Michael.
I thought I would add a bit of color to the statistics. Look at the imports by commodity (http://www.customs.gov.cn/publish/portal0/tab400/module15677/info189722.htm). Separate them roughly into commodities (mostly metals and oil) and consumables. There’s a slight double-counting in consumables because of the mechanical and high-tech goods. Compare them on a dollar basis:
Imports Year-on-year dollar-basis comparison:
Aug09: Comm -29.1%, Consume -14.8%
Sep09: Comm -9.7%, Consume -2.7%
Jan09-Aug09: Comm -32.4%, Consume -19.6%
Jan09-Sep09: Comm -29.8%, Consume -17.5%
Imports Month-on-month dollar-basis comparison:
Aug09: Comm -9.2%, Consume -3.4%
Sep09: Comm +14.4%, Consume +19.4%
Hi Michael,
Interesting. I just read an article by Yoshiaki Nakano, a Brazilian economist, pointing out that instead of an open trade war more difficult to maintain what is happening is a dissimulated currency war. Brazil, whose currency has appreciated recently 29%, imposed yesterday a 2% tax on foreign financial investments. It seems that this is just the first of a set of measures they don´t want but will have to implement to revert the appreciation. Other emergent economies that hasn´t done so will have to do it also. Who will be left? Japan, EU and a few others. For how long?
Regards,
Christopher.
Most “long views” strategic analysis use the USA as the successor to the UK, usually to outline how the USA will end just as the UK did in decline. But that analytical approach fails to deal with the fact that the UK was based upon mercantalism and the USA came into its current status post WW I because it shed mercantalism.
The above insightful essay and resulting commentary indicates to me it is China who is the successor to the UK. Much of the discussion on overcapacity and stockpiling commodities could almost have been written about the UK pre- WW I.
The lesson is that mercantilism never works in the end without vigorous belligerency – the UK had a Navy that could keep the global mercantilist network going and yet it also failed in the end. (Not to mention that little anti-mercantilism trade war UK lost called the Revolutionary War which formed the USA)
China is operating a full out same ole, same ole, mercantilist economy without the usual required global military might, instead CHina has only the threat the “hard power” down the road as with growth from the mercantilism they will have that military might one day – so you better let them be mercantilists now. This doesn’t seem to be a very robust long term strategy as the rest of the world will ask the obvious questions. Why would the rest of the world finance China’s gaining the global military might needed to maintain mercantilism by allowing China to be mercantilists now?
This year, neat year, decade from now – at some point the world will not allow this trade policy no matter how much satisfaction they gain by seeing it as an offset to current USA hegemony. They will disallow this China trade policy when they feel China is starting to approach the “hard power” required after which once reached the world will no longer have a choice. The non- USA and non-Sino world feels they can play this brinkmanship to contain the USA.
China should not play this game as when the Chinese trade policy is disallowed , the wrenching changes required will make the last year look like a cake walk.
China has to shift now to where over 90% of their growth and GDP is domestic sourced – or they better expedite their plans for one heck of a navy.
This follows on a point that I made earlier on this blogsite, that these issues are really about global security and not economics.
Mike
Could you give me your email address as I would like to send you something I have just written which you will, I think, find interesting. Thanks and best
simon
Hi Michael,
I just got the correct numbers. This year´s currency appreciation against the dollar was:
Brazil: 25.23%
Australia: 23.94%
Canada: 13.90%
UK: 10.86%
EU: 6,50%
India: 5,52%
Russia: 0.58%
Japan: -0.15%
Argentina: -10.62
So, Japan is already not part of the group I mentioned in my previous comment.
Regards,
Christopher.
Here in Australia everyone from the Governor of the Reserve Bank down believes the GFC is over, China Boom 2.0 is well underway, and there are no risks ahead:
Secretary of the Treasury Ken Henry says:
“My own view is once we get through this period of macroeconomic weakness we will get back, within not too many years, a position of close to full employment and it is quite probable that in that sort of … market there will be concerns about skills shortages,” he said.
“That seems to me a quite conceivable possibility, particularly because it now appears the impact of the global financial crisis on the Chinese economy and the Indian economy hasn’t been nearly as large as many feared.
“It seems as likely to support relatively high commodity prices, that is prices for Australian export commodities, for a considerable period of time, quite possibly for some decades.
“This is one of the several adjustments that the Australian economy is going to have to make over the many years ahead.”
George, interesting comments. From a long term standpoint, I would also add that China is reverting somewhat to a central planned economy. Look at what is going on in the steel and power industries where provinces and cities are encouraging industrial development in the face of a chiding Zhong Nan Hai. Capacity continues to get added because of a number of structural problems:
1. China’s cities make money on land sales (actually leases) and so there is budgetary incentive to encourage commercial development.
2. Obviously, such investment adds to prospective employment of labor. No one wants the opposite, job contraction, lest you get a situation similar to the labor riots and killing that happened in Tonghua, when they tried to privatize an inefficient government owned steel company.
3. Don’t discount the fact that city and provincial officials stand to gain personally through the nontransparent permitting and contracting activities that go along with these investments. If, instead, resources are transferred to consuming households, which is what needs to happen, it is much harder to keep your fingers in the Emperor’s rice bowl.
It seems to me the overcapacity is causing a reversion to central directed economic decisioning.
As for rational investment decisioning, those of you in the west take for granted the consistent and transparent economic framework. (Listen to the howls of hedge funds over the 2% Brazilian tax on foreign investment.) In China, investment decisionmaking is subject to huge prospective policy swings. The central government intercedes in the pricing of many products as well as guiding the deployment of capital. Furthermore, all this happens with vague decrees that leave execution of the mandate to local officials. So, how does one make an investment decision based on this kind of world?
There is an attitude at the big SOEs (including the banks) that any investment is just the state’s money. So don’t question anything critically. Just follow procedure, listen to your leader and try to do what you think the government wants. Markets just don’t move in China the way we would expect.
Interestingly, one of the industries named as problematic and where the NDRC will take a hard line on future investment is wind power! How’s that for a clash of policies?
” 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. ”
I don’t see why China should fear any actual hostility. The process has been going on for years with no reactions whatsoever.
Just to take the US, the complete lack of reaction to Wall Street’s coup is quite telling. So the populace will take another round of globalization and de-industrialization with no more than some vague grumbling and the elites just won’t give a darn about their own country as long they get their share of the cake. Same thing with trade competitors. China can bribe its way through if needed.
You could call that the Latin-Americanization of the world by reference of South-American elites over the past century who’ve never invested in their own country, countries to which they feel no particular attachment except as a source of revenue. That detachment is becoming general.
Could you give me your email address as I would like to send you something I have just written which you will, I think, find interesting
Don’t keep it a secret Simon. Post it here for all to see.
Speaking about government influence on Banks, here is a link to a Caijing article on another financing source, Rural Cooperatives.
http://english.caijing.com.cn/2009-10-21/110288100.html
A few quotes from the article:
New loans written by rural cooperative financial institutions (RCFI) reached an all-time high 745.9 billion yuan in the first six months of this year, according to the China Banking Regulatory Commission (CBRC).
Borrowers including government companies and securities investment platforms tied to local governments have benefited from a rural lending spree that’s mirrored the nationwide activity at commercial banks since late 2008.
But staggering rural loan levels have raised concerns about default risks. Pointing to potential risks are capital adequacy ratios (CARs) of RCFI that have failed to meet regulatory standards. The average CAR for these rural financial institutions at the end of June, for example, was 4.3 percent — far from the minimum 8 percent required by regulators.
Since the system lets local governments control provincial cooperative associations, administrative interference in rural credit unions appears inevitable. The audit agency source said dangers are likely to intensify as local governments continue interfering through credit guidance.
(sic)
A Hebei Province case provides a good example of how credit union loans and governments work together – and challenge regulators.
In early April, the Hebei Provincial Cooperative Association decided to raise roughly 39.7 billion yuan from its 134 county-level credit unions under its jurisdiction and invest the money in various government-backed investment platforms around the province.
CBRC responded at the end of April by issuing a risk advisory to the Hebei’s credit issuers and ordering an immediate halt to the association’s fund-raising activities.
Figigi,
I believe you didn´t realize it but you reference to Latin America seems to be based on prejudice. Elites, everywhere, normally behave thinking only in their exclusive material “prosperity”. There is no factual support, however, for your generalized statement.
Regards,
Christopher.
To give you an idea of how the CBRC banking regulators think about Professor Pettis’ concern about escalating problem loans, see these quotes from a CBRC director in the China South Morning Post…
Mainland surge in bank loans this year need not lead to a rise in bad debts, so long as banks manage their assets well, including through securitisation, a senior banking regulator said on Wednesday.
The record lending also presents a historic opportunity for balancing growth between the country’s less-developed interior and its wealthier coastal regions, Li Fuan, a director at the China Banking Regulatory Commission (CBRC), told an investment forum.
His comments underscored how Beijing is alert to the risk that loans could turn sour, but is self-assured of its ability to steer banks through the dangers. (sic)
“At an early stage of repayment, some cash flow problems could emerge,” said Li, director of CBRC’s business innovation and supervision department.
But he said that banks could manage their portfolios by securitising assets and rolling over loans, among other means.
“If banks use these tools, the loans will not turn into bad assets on their balance sheets,” he said. “We need to see if banks can make preparations early enough.”
End quote.
Securitization? Rolling over (i.e. extending the maturity of) problem loans? Huh? Does that make you feel like the chief regulator of Chinese banks is zeroed in on sound loan management practices?
Securitization of commercial and real estate loans is non-existent in China, unless you count the creating of bad banks (Asset Management Companies) like Cinda, Great Wall and Huarong. As to rolling loans, that is nothing other than a deferral of a problem and a way to keep things from becoming NPL (nonperforming loan).
If I were the head of the CBRC, I would take this guy to the woodshed.
Michael
I’ve just finished reading an article on a topic that would pull the rug from under Chinas export economy & possibly be the cause of the Black Swan event we watch for.
The Yen. Large drop in store. Resulting in better quality, cheaper Japanese goods on offer. With their better educated, idle workforce, we could see a resurgence in Jap. exports at the expense of over leveraged Chinese exports.
Any bets on a Yuan revaluation under that scenario??
Interesting aspect.
regards from OZ.
Hello from Russia!
Can I quote a post in your blog with the link to you?
So China is aware of the potential of bad loans and is prepared to deal with it by changing the definition of bad.
Christopher Paterson,
LOL!
I’ll tell that to the South-Americans around me. You should also expose your views to US bankers. I’m sure they’ll be very interested :>
Krugman on Chinese yuan:
http://www.nytimes.com/2009/10/23/opinion/23krugman.html?_r=1&hp
Just making the point that we’re seeing the same thing as 2003-4 as the dollar weakens against major currencies. I’m not convinced that the trade surplus will come down from here and it very well may start taking off again.
Jeff – agree with your comment ; it’s a pass the parcel game, heaven help the one who gets the parcel when the music stops ; wonder if he’s read anything about the credit crisis?
talk about short term memory loss…
Chinese have several roadblocks to expansion looming ahead. The Chinese economy is very robust right now, but they depend heavily on exports. In a healthy global economy that’s fine, but not in an unhealthy economy. Right now protectionism is almost inevitable. I work in the chemical industry and there are several chemicals I buy from China that have pending FTC anti-dumping lawsuits. The FTC always sides with the US companies in these cases. I’m for US economic growth, but also believe free trade eliminates a lot of inefficiencies. It forces US companies to compete internationally, and look for a competitive edge. When you rely on protectionism to grow your business your business model has weaknesses.
Michael, I cannot say I can dispute your confusion. I hold to the deflation idea mainly because I believe they have pushed credit as far as it can be pushed. Being the US and Britain form much of the backbone of world credit creation and demand in the US is the backbone of the majority of export demand in the world, I sense that deflation is the direction. On the contrary, it is quite possible the US could be looted to the point that the rest of the world would drop the dollar, which would cause worldwide bankruptcy.
I have sensed for a few years there has been a corner in copper and it appears if this is true that it is being aided and abetted by Chinese hoarding. Now would be the ultimate time for the cornered to get out and leave someone else holding the bag. The collapse in homebuilding and commercial construction around the world has to have provided a huge hit to the copper business. I sense China and India to some extent have pushed the idea of growth to the point beyond markets. In the meantime, Wall Street, the US government and the Fed are set on destroying the US in order to save the equity of the banks.
A partial explanation for some of the commodity buildup has to do with production and purchase quota agreements signed into by Chinese mining firms in other countries (Asia, Africa). Many of these contracts were signed during the peak of the commodity bubble, and production is only now coming on line. That China might not have anything useful to do with the material right now does not free them from the contractual requirement of purchase. It’s a little more difficult to renege on an expensive mining operation than to do what the SOE’s did with Goldman, Morgan et al on derivative-hedges-gone-wrong. Failure to abide by the former mining contract would at least present the possibility of immediate nationalization and substantial loss.
Dear Joe Shareholder,
Absolutely agree with the concept of free trade. But trade is a two way street and China does a masterful job of talking the talk while avoiding walking the talk.
Controlled exchange rates, arbitrary regulatory rules, inconsistent application of the law all are effective means of keeping foreign competitive products at bay.
This is not to say the US, the EU or the Aussies are clean either. It’s just that no country is more vocal than China about free trade while maintaining a system that stacks the deck against foreign firm.
Not sure if this link still works (and you have to have a subscription china South Morning Post) but here is Shirley Yam’s great column on the new China Antitrust law.
http://www.scmp.com/portal/site/SCMP/menuitem.2af62ecb329d3d7733492d9253a0a0a0/?vgnextoid=7ca8217311da2210VgnVCM100000360a0a0aRCRD&ss=Columns&s=Business
To summarize her point, while indigenous China mergers occur without contest, cases involving foreign firms get the attention. Coca Cola/Huiyuan, Mitsubishi/Lucite, InBev/Annheuser Busch are the 3 cases that have resulted in Ministry of Commerce action.
Furthermore, China’s domestic economy that does not operate in a market way with heavy government intervention in output pricing, capacity (expansion and contraction), employment, input pricing, etc…how can one ever hope that there will be a level playing field if government officials micromanage?
Even if the CCP central committee wanted to promote free (let’s say impartial) trade in the China markets, the fact is that the decisions that are critical to a successful product launch and business operation are often made by local city and provincial officials who usually have a different agenda. Even supposed central regulatory bureaus like Ministry of Commerce, the CSRC and others have branches offices in various cities where the local officers do not administer the regulations consistently.
Of course, there are all very good, innocent explanations as to why China has these institutions and economic structure. But the reality is that such structural controls can be used for perverse reasons as well…and they are.
The Economist had a good article called “Impenetrable” in its October 15th edition. Here is an excerpt…
_____
Local officials go to great lengths to protect companies on their patch, often by giving them preferential access to land or credit, or by easing bureaucratic constraints for them. All the red tape would at least provide plenty of work for multinational law firms, were they permitted to employ Chinese lawyers–which they are not.
_____
I continue to scratch my head as to how the WTO can assure fair trade with countries whose indigenous economy is not even close to a market system.
Michael,
Great to see the comments working again, and great to see the hypothesis that led one to believe this to happen after the anniversary celebrations, confirmed.
The stockpiling of a voluminous and relatively inexpensive commodity like iron ore continues to puzzle though. Not quite your speculators assets and very high transaction costs when liquidating. Maybe some producers expect the gvt to ration iron ore imports in the future in order to force a long overdue consolidation and rationalization of the sector. In that case the marginal steelmakers would tend to import disproportionally.
Apart from speculative and strategic explanations (iron ore) , I believe that commodity imports have become a short term policy instrument, in order to manage the CA. Not quite sustainable though unless there is a world wide recovery, to which China’s peculiar style of stimulus, as you have argued regularly, will contribute much less than the raw numbers would suggest.
http://raphaelkahan.blogspot.com/2009/10/buiter-on-bubbles-and-china.html
bull chart you teem with