Archive for the ‘China’ Category

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China is being accused of starting a new currency war. The People’s Bank of China has devalued the Chinese currency three times in three days. Politicians on Capitol Hill can barely conceal their ire. There is even talk that both the Fed and Bank of England will hike interest rates as a result. Yet for all that, it may simply be that China is doing what both the IMF and Washington have been calling for it to do for years.

China wants its currency, the yuan, or the renminbi, to be part of the basket of currencies that make-up the IMF’s Special Drawing Rights, or SDR.  For this to happen, the IMF says that the yuan must be allowed to trade freely on the open markets. China say that this is precisely what it is doing.

There was a time when China manipulated its currency, keeping its value artificially low. To achieve this, the government went out and bought western bonds, especially US government bonds. This in turn pushed up on the value of those bonds, causing their yields to fall. It’s an important point that often gets overlooked. Some criticise the Fed’s polices over the years, but truth be told in the long term, it is not central banks which determine interest rates, but movements of money which in turn can be changed by deep forces at play.  China’s policy of maintaining a cheap currency was a major factor in creating low interest rates for much of this century. And while the cheap yuan theoretically led to lower US exports, US borrowing was partly funded by China, and at exceptionally low interest rates.

It is just that the yuan is no longer cheap.  It hasn’t been for some time. If the yuan really was allowed to trade freely, it would surely fall in value. Washington can scream with fury, but China is gradually moving towards a position that the US has wanted it to occupy for years.

After the first devaluation, the IMF said “The new mechanism for determining the central parity of the Renminbi announced by the PBC appears a welcome step as it should allow market forces to have a greater role in determining the exchange rate. The exact impact will depend on how the new mechanism is implemented in practice. Greater exchange rate flexibility is important for China as it strives to give market-forces a decisive role in the economy and is rapidly integrating into global financial markets. We believe that China can, and should, aim to achieve an effectively floating exchange rate system within two to three years. Regarding the ongoing review of the IMF’s SDR basket, the announced change has no direct implications for the criteria used in determining the composition of the basket. Nevertheless, a more market-determined exchange rate would facilitate SDR operations in case the Renminbi were included in the currency basket going forward.”

Some say the timing is cynical, because China has devalued in the same week that saw weak data on industrial production investment and retail sales. That may be right, but so what. China is simply doing what the IMF has recommended, but chosen the most fortuitous moment. What’s wrong with that?

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There are almost as many opinions as there are Chinese. Some say the Chinese growth miracle is at an end. Others see a temporary lull. Others still, point to demographics and see problems ahead. Yet others say we are confusing western culture with that of China; that it is unstoppable. Some go even further and say that China – via its system of central control – has been deliberately manipulating a system and it will soon reign supreme over the global economy. Or to put it another way: some say ‘this time it is different’, and although China portrays many of the hallmarks of a bubble, it is just different from the West, while others say the claim that ‘this time it is different’ is always – and without fail – a sign that things are set to come very badly unstuck.

You may have picked up on the irony. After 1989, the consensus seemed to be that capitalism had won; that any system of central control was doomed to fail. Now there seems to be a view held by many that China is unstoppable precisely because it has so much central control that its state can force through reforms and regulations that western governments can only dream of.

This view is almost certainly wrong. For one thing, to argue that China is unstoppable because of its central control appears to be ignoring the lesson of the history of the last half of the 20th century. For another thing, it is debatable how much power the Chinese government really has. China is a massively complex country, and while Beijing may issue directives on how things must be done, the extent to which they are followed across the country is open to debate. In any case, China’s government is terrified of social discontent. For the country’s government there is always the fear of how the people will react if the government mismanages the economy.

This fear of popular discontent can often stop the government from doing precisely the things it should do for longer term prosperity. Take as an example its policy regarding its currency – the yuan. The US government is screaming at China to let the yuan trade freely. Many US politicians blame a cheap yuan on just about all of the US ills. They are surely wrong, but there is no doubt that if the yuan were to rise, US exporters would benefit, but how much is open to debate? But what people often overlook is that there is very strong evidence to suggest that China too needs a more expensive currency.

A consequence of China’s currency policy has been too low interest rates, which has all kinds of undesirable consequences – among them a credit bubble, too much emphasis on investment, and there appears to be evidence that low interest rates have led to Chinese companies paying out lower dividends, which has helped to accentuate imbalances in the economy.

Part of China’s problems can be dated back to 2008, when the West hit the crisis button. China responded with a massive stimulus of its own. It kept growing during the worst days of 2008 and 2009 but at what cost? According to the IMF, in 2008 China’s money supply jumped 30 per cent – and that is ironic. While China was accusing the West of debasing its currencies via QE, and lecturing the US on living within its means, China began to apply the kind of policies that got the West into its mess in the first place.

Then there is credit. In 2008 total outstanding credit in China was 130 per cent of GDP – a level that had pretty much been unchanged for several years. Now the ratio is at 187 per cent – that was a massive hike for just half a decade. The IMF has said that when a country sees credit increase by 3 per cent of GDP or more in a year, there is a good chance that a crisis may follow. Yet In China the rate of credit growth dwarfs what the IMF might refer to as the danger level.

For China corporate sector debt is the real danger. This has risen from just over 20 trillion yuan in 2007 to over 60 trillion in 2012.

This may all sound like western cynicism, but just remember it was the man who until last year was China’s premier – Wen Jiabao – who described China’s economy as, “unstable, unbalanced, uncoordinated, and unsustainable.”

It is not all woe, however. Recent anecdotal evidence such as the latest Purchasing Managers’ Indices, and data on freight transport, electricity output and volume of cargo all point to China’s economy seeing a mild pick-up. It is not going to see growth in excess of 10 per cent again for a while – if ever – but the recent data is consistent with growth of around 7.5 per cent, which is much better than many had warned.

The pick-up may be occurring because once again China is implementing short-term policies to push up growth via the very things that it has too much of anyway – namely investment, government spending, credit. But with signs that the US economy is at last on the mend, it may be possible for China to tighten up monetary policy allowing the yuan to rise, without taking too big a hit on exports.

Looking further forward, what China really needs is higher wages. Well this is happening. McKinsey has forecast that by 2022, 75 per cent of China’s urban workers will earn between $9,000 and $34,000 – a level that sits half way between current levels in Italy and Brazil. To put this figure in context, in 2000 just 4 per cent of Chinese urban workers had earnings falling within that band. McKinsey also forecasts that by 2022 urban income will double from current levels. These are precisely the developments China needs.

Then there is education. The OECD measures pupil skills in reading, numeracy and science, in a test known as PISA. The BBC recently quoted Andreas Schleicher, a leading figure behind these PISA tests, saying there are signs that China is closing – if it has not already closed – the education gap with the West. Shanghai has excelled, but said Mr Schleicher: “What surprised me were the results from poor provinces that came out really well. The levels of resilience are just incredible.” He said that he gets the impression China is investing in the future. Unlike the US, there are indications of a high degree of education equally between rich and poor.

China’s next big challenge is how it can manage being a middle income country. Over the last half a century only a handful of countries managed that transition. Many saw rapid growth, but then stopped before income levels had reached anything like western levels. Will China be one of those rare successes?

It does have one major hurdle to climb, however, and that is demographics. According to the UN, the population of China aged between 15 and 59 is set to fall by 7 per cent between 2010 and 2030. The policy of one child per family is about to be relaxed, but even so, many Chinese couples don’t want more than one child. In any case, even if the birth rate shot up overnight, it would take the best part of two decades before this showed up in the work force.

Associated with demographics is the question of the so-called Lewis Turning Point – a point familiar to economists – when a country runs out of workers to migrate into urban areas.

Let’s finish with what the IMF says on this subject: “Within a few years the working age population will reach a historical peak, and will then begin a precipitous decline. The core of the working age population, those aged 20–39 years, has already begun to shrink. With this, the vast supply of low-cost workers—a core engine of China’s growth model—will dissipate, with potentially far-reaching implications domestically and externally. The reserve of unemployed and underemployed workers (which is currently in the range of 150 million)—will fall to about 30 million by 2020 and the LTP [Lewis Turning Point] will be crossed between 2020 and 2025.”

For more see:

IMF: Chronicle of a Decline Foretold: Has China Reached the Lewis Turning Point? 
Trading Economics: China Labour Costs 
Ernst and Young: China’s productivity imperative 
FT: China’s debt in charts
McKinsey: Mapping China’s middle class 

© Investment & Business News 2013

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You may have heard of Solomon Asch. He was the psychologist who helped to introduce us to the idea of group compliance. In his famous experiment, subjects were handed two pieces of paper. On one was drawn a line; on the other three lines. One of the lines on the second sheet was the same length as the line on the first; the other two lines were obviously different.

Subjects were asked to identify which line on the second sheet was the same length as the line on the first. It was an easy test, and nearly all subjects got it right.

Then he played a trick on them. Subjects were put into a group situation. Unknown to them, the rest of the group were actors, and each actor deliberately pointed to the wrong line. It is not hard to imagine how the subjects reacted; their sense of panic or of self-doubt. In fact, in the original Asch experiment no less 74 per cent of those who took part complied with the group, getting the obvious right answer wrong on at least one occasion.

The Asch experiment illustrates how bubbles, even wars, can occur, as individuals comply with the crowd. It is interesting to note, however, that if one actor goes against the rest, and guesses correctly – or perhaps wrongly but with a different wrong answer from everyone else – the subject was far more likely to go against the crowd. It does not take much to break crowd compliance.

The Asch experiment has been repeated worldwide, and it was found that group compliance tended to be slightly higher in countries seen as having a more cooperative and less individualistic culture, such as China. Now don’t over-egg this one. The difference is not that great, but it does go to show that – contrary to what some argue when they say China is different – there are reasons to think China is just as susceptible to bubbles as the rest of us.

© Investment & Business News 2013

It is not often that we get a chance to test theories, at least not when it comes to the economy. But we have such a chance right now, and it relates to China, and whether or not China is experiencing its own credit crunch, or something altogether less serious.

Critics of Mervyn King and Ben Bernanke said that they misread things before the crisis of 2007/08 erupted. These critics say that during the build-up of the credit bubble, central banks should have hit the brakes, and upped interest rates. In short, like the very best party pooper, take away the punch bowl just as things start to get going.

Right now, in China, it appears that the central bank – presumably under instructions from the government – has taken away the punch bowl. The markets don’t like it, but then maybe on this occasion that is how it should be.

The interbank rate in China – that is the interest rates at which banks lend to each other –has soared. Déjà vu say those who recall what it was like in 2007 and 2008 in the West, when the words credit and crunch first started to appear in the same sentence.

It is just that some say China is not at that stage yet. Sure, signs of a credit bubble are clear, but it is not like the UK and the US during the height of their bubble – not yet.

The People’s Bank of China, or PBC, published a note last week saying: “Liquidity for the banking system as a whole remains at a reasonable level.” And since the PBC tends to follows the dictates of government, it is generally assumed that is the view of China’s government too.

China’s State Council recently stated: “We must promote financial reform in an orderly way to better serve economic restructuring.” Again, this suggests the government wants to rein back all that borrowing.

There is one major difference between China’s credit bubble and the one we experienced in the West. In the economy behind the Great Wall, it is local government and state owned companies that are hitting the credit button.

What China needs is for less money to be thrown at investment projects and more to trickle down into wages. In the case of China, squeezing credit may boost consumer spending – in the long run at least. It is all part of the process of adjustment China must go through as it shifts from investment to consumer led growth.

China’s government appears to understand this.

Interest rates are going up – at least that’s the way it looks. They are going to go up in the US, as the Fed has suggested, and they appear to be rising in China, as the government wants.

In the case of the US, if rates rise it will be because of good news on the US economy. If they rise in China, it is because the government is trying to learn from the lessons of Alan Greenspan and Ben Bernanke.

© Investment & Business News 2013

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Anthony Bolton was an investment star. When he turned to China, the investment community waited with bated breath. They are still waiting, and now Mr Bolton has announced his planned retirement.

If you had invested £100 into Anthony Bolton’s UK Special Situations fund, and left it there for 28 years, it would have been worth £15,220. Not a bad return.

No wonder Mr Bolton was heralded as the UK’s answer to Warren Buffett.

And when the great man turned his considerable ability to mastering China, investors flocked to his cause.

That was in April 2010. Alas, shares in The Fidelity China Special Situations Fund run by the investment star, have fallen 17 per cent or so since then. Not a good return.

In fairness to Bolton the CSI 300 – that’s the stock market index tracking Chinese shares that investors pay the most attention to – has fallen from 3,345 in April 2010 to 2,403 at the time of writing, so it is hard to make money at such times.

Maybe the investment approach adopted by Mr Bolton in the UK for all those years just does not work in China.

Maybe, it’s just a matter of timing. The Bolton investment strategy is quite risky, and high risk means high volatility. At certain times investors in his funds lost money, but if they stayed true, in time they did very well indeed. Maybe the same could have been said for Bolton’s China’s fund, it is just that right now is a not a good moment to make a judgement.

Maybe the problem was that Mr Bolton just doesn’t know China well enough.

The man set to take over at the Fidelity China Special Situations is Dale Nicholls. He has managed the Fidelity Funds Pacific Fund since September 2003 and over that period he has returned 154 per cent. So that’s not bad, either. Fidelity says: “Dale is a bottom-up stock picker with a growth bias and a significant tilt towards smaller and mid-cap companies.”

Maybe though the problem for Anthony Bolton – and this may apply to his successor too – is straightforward regression to the mean.

If an investment delivers a one-hundred-fold return, we can be fooled into thinking we had more influence than actually we did. Should we repeat our efforts many times, regression to the mean may mean that our average performance is more mediocre. A sportsman, or pop star, or serial entrepreneur may enjoy a run of success, but the more often they try to repeat their success, the more likely regression to the mean will occur.

Leonard Mlodinow of the California Institute of Technology used the metaphor “The Drunkard’s Walk” in his book of that name to explain the idea. He tells the story of Sherry Lansing, top brass at Paramount, who commissioned ‘Forrest Gump’, ‘Braveheart’ and ‘Titanic’. She was a “genius”, who then “lost her touch”. She was fired, following one flop after another.

In the year or so after her departure, the studio enjoyed a run of hits. So, its decision to fire Lansing was proven right, or so it appeared. However, films such as ‘War of the Worlds’ and ‘The Longest Yard’ had already begun under Lansing’s tenure. Mlodinow also quotes a Hollywood executive who reportedly said: “If I had said yes to all the projects I turned down, and no to all the other ones I took, it would have worked out about the same.”

© Investment & Business News 2013

China is not happy with the EU, the EU is not happy with China, and the British Solar Trade Association seems to side with China.

The EU has imposed anti-dumping duties on China’s solar panel exports. China has responded with tariffs on Europe’s wine exports.
Actually, this is the EU compromising. It is phasing in the tariffs much more slowly than originally intended, and they will, in any case, be at a much lower rate.

The EU says China is using subsidies to sell its panels on the cheap, and reckons they should be some 88 per cent more expensive.
On the other hand, the solar industry has received large subsidies in Europe, too.

Ray Noble, PV Specialist at Solar Trade Association (STA), reckons that the real problem for the EU is that the European industry has not invested as much as it should have. It has taken the money from subsidies, and, as it were, run. China has invested far more and consequently enjoys greater scale. That is why it can sell panels for less money than European companies.

STA CEO Paul Barwell recently said, “If duties are imposed, panel prices will rise across the board, and consumers and installers alike will lose out. It makes no sense to safeguard 8,000 manufacturing jobs by sacrificing up to 200,000 jobs in the wider industry.”

Mr Noble said, “I suggest David Cameron and Angela Merkel work together to sort out these absurd rules and remove this lingering market uncertainty, so that industry can get on with installing low cost, clean and affordable solar energy.”

© Investment & Business News 2013

It appears that the Chinese economy lurched backwards again in May. The Eurozone remained firmly in recession, or is that depression? So much for things looking up!

You may know that the Purchasing Managers’ Indices follow a formula, with any score over 50 meaning expansion; under 50 indicates contraction. However, with China it is not that simple, and normally a score under 50 suggests growth slowing rather than outright contraction.

This morning the flash composite PMI for China from HSBC/Markit and for the Eurozone from Markit were out.

These are preliminary readings, with the fuller and more accurate PMIs due out at the beginning of June.

The May flash composite PMI for China was 49.6, the first reading under 50 since last October. The May flash composite PMI for the Eurozone was 47.7, the highest reading in three months but still consistent with recession.

Let’s see what the more accurate and detailed PMIs for both China and the Eurozone say in ten days’, or so, time.

© Investment & Business News 2013