Tuesday, March 25, 2014

China: Minsky Moment or more stimulus?

The headlines in China have been nothing short of dismal. Hardly a day goes by without another negative data point, such as the story about a tanking M-PMI (via Zero Hedge):

John Mauldin featured an article by his associate Worth Wray entitled China's Minsky Moment last weekend. I won't go through all of it, but China's problems should be familiar to the readers of my blog. Wray detailed the problems caused by a dwindling supply of cheap labor, debt fueled white elephant infrastructure spending, falling growth to debt increase ratio, which indicates diminishing returns to debt fueled growth, and so on. He concluded:
Over the last 50 years, every investment boom coupled with excessive credit growth has ended in a hard landing, from the Latin American debt crisis of the 1980s, to Japan in 1989, East Asia in 1997, and the United States after both the late-1990s internet bubble and the mid-2000s housing bubble.

The lesson is always the same, and it is hard to avoid. Economic miracles are almost always too good to be true. Broad-based, debt-fueled overinvestment (misallocation of capital) may appear to kick economic growth into overdrive for a while; but eventually disappointing returns and consequent selling lead to investment losses, defaults, and banking panics. And in the cases where foreign capital seeking strong growth in already highly valued assets drives the investment boom, the miracle often ends with capital flight and currency collapse.

John and I talk about China constantly and always reach the same conclusion. We really have no way of knowing whether the country will suffer a modest slowdown or a hard landing, but we both agree with George Soros that “The major uncertainty facing the world today is not the euro but the future direction of China.”
You get the idea of the general tone.

A Minsky Moment?
Is China on the verge of a Minsky Moment where growth collapses?  Events don't always evolve in a straight line. Consider how the Chinese leadership might react in reaction to the recent news about bank runs:
Hundreds of people rushed on Tuesday to withdraw money from branches of two small Chinese banks after rumors spread about solvency at one of them, reflecting growing anxiety among investors as regulators signal greater tolerance for credit defaults.

For now, the minor panic has occurred in smaller banks:
Chen Dequn, a resident in Yandong, just outside Yancheng, said she saw a crowd of about 70 to 80 people gathering in a branch of Sheyang Rural Commercial Bank in her town on Tuesday.

"At the moment there are about 70 or 80 people in there. Normally there'd only be about 10," she told Reuters by telephone.

Officials at another small bank, Rural Commercial Bank of Huanghai, said they had faced similar rushes by depositors, triggered by rumors of insolvency at Sheyang.

"We will be holding an emergency meeting tonight," an official at the bank's administration office told Reuters, but declined to comment further.
As well, protests have sprung up over falling prices as stresses appear in the property market, (via Zero Hedge):
Hell hath no fury like a woman scorned or, it seems, like a Chinese real estate speculator who is losing money. After four years of talking (and not doing much) about cooling the hot-money speculation that is the Chinese real-estate bubble (mirroring the US equity market bubble since stock-ownership is low in China), the WSJ reports that the people are restless as the PBOC actually takes actions - and prices are falling. With new project prices down over 20%, 'homeowners' exclaim "return our hard-earned money" and "this is very unfair" - who could have seen this coming? 

Stimulus on the way?
The current rhetoric is about focusing on reform and to transition to a market based economy and to avoid the mistakes of the past. CNBC reported that Vice Finance Minister Zhu Guangyao stated that, even if they were to embark on a new round of stimulus, they would not repeat the mistakes of the past, i.e. credit-fueled infrastructure growth. However, you have to read between the lines (emphasis added):
Amid growing talk that China may take steps to stimulate a slowing economy soon, the country's vice finance minister told CNBC that Beijing would be careful not to repeat past mistakes.

Last week, China's Premier Li Keqiang said the government should roll out measures as soon as possible to stabilize growth and boost domestic demand, China's state news agency Xinhua reported.

Vice Finance Minister Zhu Guangyao told CNBC in an exclusive interview on Sunday that authorities would take a cautious approach and was mindful of the negative impact stimulus has had on the economy in the past.
What is the solution to infrastructure spending? CNBC reported that Beijing has unveiled an urbanization plan, a solution which was endorsed by the World Bank (emphasis added):
Urbanization of China's population has become one of the most important elements in the mainland's shift toward domestic consumption and away from investment-led growth, said Sri Mulyani Indrawati, chief operating officer at the World Bank.

"Chinese leaders recognize the inefficiency and (are aiming for) less reliance on investment," she told CNBC from Beijing at the launch of a World Bank report on urbanization. "Urbanization has become one of the most important parts of shifting the growth model," she said.

She expects the shift will require a lot of policy adjustment, with reforms needed on land policy, including imposing a property tax to substitute revenue for local governments to provide services for their cities' populations. Local governments have been relying on revenue from selling land to convert it into urban space, she noted.

"To maintain [economic] growth at 7.5 percent, [with] better quality and more inclusive, the change is really needed," she said. "They have to change the ecosystem. That is not only going to require the fiscal space, or the ability to finance it, but also the ability to provide those services to many of the migrants moving from the rural to the city area."
A report from the FT gives further details on the urbanization plan. How is this different from the same-old-same-old infrastructure spending approach?
As part of the planned infrastructure construction, the government plans to ensure that every city in China with more than 200,000 residents will be connected by standard rail and express roads by 2020, while every city with more than 500,000 residents will be accessed by high-speed rail.

New airports will be built to ensure that the civil aviation network covers about 90 per cent of China’s population.

The plan also calls for the redevelopment of 4.75m household units in rundown shantytowns this year alone, with an expected total cost of Rmb1tn ($163bn), according to state media reports.
The FT article detailed the real agenda of the Chinese leadership:
Over the longer term, China’s leaders want to shift the country’s growth model to make it less infrastructure driven and more reliant on services and consumption, but they insist that they must keep investment levels high in the short term to guarantee employment and political stability.
Bottom line: When push comes to shove, employment and political stability trumps everything else. As growth slows and stresses start to appear in the financial system, expect Beijing to unveil another round of stimulus based on credit driven infrastructure spending their urbanization initiative. As well, watch the New China-Old China pair trade and expect it to reverse temporarily in favor of the financials at the expense of the "New China" consumer spending oriented companies.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.

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