Trade war may be brewing between China and the US

How times change. Just last year, China was being hailed as this decade’s economic miracle. Growth was in double-digits, the stock market had morphed into a cash machine, and just about the only cloud on the horizon was inflation caused by the soaring price of pigs.

But a short 14 months later, property prices are plunging, stocks have plummeted by two-thirds from their peak and all that growth’s grinding to a halt.

The Chinese authorities are getting more and more jittery. And their reactions to the downturn could deliver the next big hit to a crumbling world economy...

China’s lesson in economics for America

In October last year, the IMF concluded that for the first time in modern history, China was about to overtake the US in its contribution to the planet’s economy. In expanding by 10%, the country would pump more money into the global system than would poor old Uncle Sam with its paltry 1.9% growth.

For the Shanghai stockmarket, that proved to be the peak - almost to the day.

Although the IMF’s thinkers had factored in a likely economic slowdown in the ‘developed’ world, they were wrong to assume that China would be able to “de-couple” from the West.

Now, with exports collapsing, China’s suffering just as much as Europe and the States. And this week, China’s top men have been telling US Treasury Secretary Hank Paulson exactly where he went wrong.

Our Hank has taken a break from his efforts to ‘save’ the US financial system for a two-day jaunt – sorry, “strategic economic dialogue to discuss long-term bilateral issues” - in Beijing. But it’s no cakewalk. Poor Mr P walked into what the FT’s Geoff Dyer calls “a new lecture about US economic fragilities”.

“Over-consumption and a high reliance on credit is the cause of the US financial crisis”, said Zhou Xiaochuan, governor of the Chinese central bank. “The US should adjust its policies, raise its savings ratio and reduce its trade and fiscal deficits”. And vice premier Wang Qishan urged the Americans “to stabilise the economy and financial markets as well as guarantee the safety of China’s assets and investments in the US”.

Why China wants a stronger dollar

The Chinese may have nailed America’s financial problems. But the trouble is, they aren’t quite as keen to see the US actually stop spending. Because America’s profligacy, and heavy spending on Chinese goods, has been one of the main factors driving China’s economic boom.

With the US consumer out of the picture, China’s domestic economy is getting hammered. President Hu Jintao has warned that China is “losing competitive edge in the world market”. The manufacturing sector has seen its steepest decline since records began, and Chinese workers are not only losing work, they’re getting very angry about it. There have been violent protests in Guangdong due to the mass closure of factories making toys, textiles, and furniture.

So after more than three years of the Chinese currency appreciating some 20% against the US dollar, i.e. making American goods cheaper, the game has now changed.

Twice this week, the Chinese central bank has lowered its ‘dollar band’, including allowing the biggest drop in the renminbi against the greenback since the dollar peg – a fixed exchange rate since 1997 - was ditched in 2005.

This may sound of interest only to currency exchange students. But it isn’t. It means the Chinese are now prepared to start depreciating the renminbi against the dollar. And it has the ammunition, with nearly $2,000bn of foreign exchange reserves, having last month overtaken Japan to become the largest foreign holder of US government debt.

By dropping the value of their currency and so making their goods cheaper, the Chinese hope to gain further export share abroad. And at the same time, they’ll be losing less money on all those US Treasuries they hold.

China’s plans could set off a dangerous chain of events

Yet there’s a very big snag. Any currency policy reversal “risks setting off conflict with Barack Obama’s incoming team”, says Evans-Pritchard. “Obama called China a ‘currency manipulator’ during the election campaign, a term that carries penalties under US trade law”.

In short, just when the planet doesn’t need any extra trouble, a lot more is brewing up. So what does it all mean for investors?

The futures markets are already ‘pricing in’ a 6% renminbi devaluation over the next year. “I really believe we’re on the brink of a very ugly period for trade relations”, says Professor Michael Pettis at Beijing University.

But worse, any slight flickers of reviving manufacturing growth in the West could be snuffed out by a fresh flood of cheaper Chinese imports. China's policy switch could set off a dangerous chain of events, says Hans Redeker at BNP Paribas: “If they play this beggar-thy-neighbour game, it will cause a deflationary shock for the whole world”.

Hardly the ideal recipe for stock markets. But it sounds like it could be well worth hanging onto those government bonds for now. For more on deflation – and what might follow it – read this week’s issue of MoneyWeek, out today.

Turning to the wider markets...


Unimpressed by the Bank of England's big interest rate cut, the FTSE 100 finished down 6 points yesterday to close at 4,164. Financial stocks, though, did take heart. HBOS rose 7.4%, Legal & General was up 6.4% and hedge fund Man Group climbed 5.5%. Housebuilders also had a good day, with Barratt up 9.4%. Miners, however, performed badly, with Xstrata down 7.7% and BHP Billiton down 7%. For the latest stock market news and charts.

Over in Europe, the Paris CAC 40 lost 5 points to end at 3,161; the German Xetra Dax, meanwhile, fell 3 points to 4,564.

In the US, Wall Street ended the day on a low note after concerns about US employment figures. The Dow Jones Industrial Average slipped 2.5% to close at 8,376, while the wider S&P 500 lost 2.9% to 845. The Nasdaq Composite lost 3.1%, ending at 1,445.

In Japan, the Nikkei 225 closed down 0.1% at 7,917 after a very volatile day. The Topix index fell 0.4% to 786. Banks were among the biggest losers, with Mitsubishi UFJ falling 5.4% and Mizuho falling 6.7%.

Brent spot was trading at $41.13, early today; and in New York, crude oil was at $43.90. Spot gold was trading at $767 an ounce, silver was at $9.51 and platinum was at $803.

In the forex markets this morning, sterling was trading against the US dollar at 1.4719 and against the euro at 1.152. The dollar was trading at 0.7829 against the euro and 92.13 against the Japanese yen.

And this morning, the credit crunch has hit Formula 1 motor racing as Honda announced they are to quit, dealing a major blow to the sport. Honda said it could no longer bear the $500m a year cost to run the team. The pullout has raised fears that other teams such as Toyota could also be rethinking their position.

Courtesy : Money Morning

Saving China, rescuing India

In 1949, said the speaker from Shanghai, Communism saved China.

He was, of course referring to the 20-year civil war in China and subsequent ascension of Chairman Mao as the ruler of China.

In 1982, continued the speaker, Capitalism saved China. He was, no doubt, referring to the fact that the Red Book of Chairman Mao had resulted in China joining the ranks of India and Africa as economic basket-cases of the world. Communism - as in Soviet Union and China - had failed to deliver the promised goods.

In 2008, ended the speaker with a flourish, China is being asked to save Capitalism.

He was, no doubt, referring to the fact that the world increasingly looks to China to save it from the economic crises that keep popping up everyday.

On November 26th, the Indian stock markets zoomed in the last hour of trade. Alas, this was not because the CPI (M) and other forms of communists that exist in India had decided to give up their effort to save Communism. But, rather, it was because China has announced that its key lending rate will drop by 1.08% to 5.58%. This, notes the Bloomberg article excitedly, is less than 3 weeks after China has announced a 4 trillion yuan (USD 586 billion) stimulus package.

As this news hit the wires, the European stock indices reversed their earlier decline and surged 2% to try and crawl into the positive territory. China may end up saving Europe, figured the punters


Under the sheen

But maybe all that China is really doing is trying to save itself!

Over the past two decades, as China’s factories churned out clothes, microwaves, stuffed toys, and television sets to be exported to the rest of the world, its humming factories needed workers. In response to promises of higher wages and some basic amenities, hundreds of millions of labourers have moved from the countryside to urban areas.

On the way up the economic steps of the golden export ladder, that was good. China’s industrial miracles gave it over USD 2 trillion in foreign exchange reserves. While that is one measurement of success, consider the potential harm from the unwinding of this export-led economic boom.

Says Bloomberg: ‘China, the world’s most populous nation, is targeting growth of 8 percent a year to provide jobs for workers moving to the cities from the countryside. A decline in economic growth to even 8 percent would be tantamount to a recession, said Tao Dong, chief Asia economist with Credit Suisse AG in Hong Kong.

The outlook for jobs next year is "grim", said Yin Weimin, head of the Ministry of Human Resources and Social Security said last week. Two thirds of small toy exporters closed down in the first nine months of this year, the customs bureau said this week.

About 1,000 police and security guards attempted to break up the demonstration as sacked toy company workers overturned a police car, smashed four police motorbikes and broke equipment in southern China’s Guangdong province yesterday, Xinhua News Agency reported.’

If 100 million people - out of jobs - have to move from urban China to rural China that will be a Great Leap Backward. If another 100 million people cannot see opportunities in urban China and are forced to stay back in rural China, then that requires an alternative economic activity to be created for them.

The Chinese economic miracle needs to be juxtaposed with a "quality of life" factor. The monetary wealth created by paying higher salaries and increasing incomes to hundreds of millions of its citizens was at the cost of a lower quality of life - a problem faced by all countries when they are trying to break out of poverty. The people tolerated bad air, poisoned products, and lack of freedom because there was a monetary compensation - and a promise of good times. Much of that monetary wealth is under threat of evaporation - but the qualitative negatives still hang in the air.

What China is seeking to do is rescuing itself. Not from a disaster but the possibility of a disaster if their own economy slows down further.

Reducing interest rates and giving banks the flexibility to lend out more money (by reducing the reserve requirements) is in the hope that domestic consumption will increase. If factories stay occupied, jobs will be retained. China will be rescued.

India needs to build

And India, with its hundreds of millions of unemployed and under-employed, is also in a rescue mode. Luckily for India, the export-led boom was more limited to a few industries and to the mass export of human talent from subsidised institutes of higher learning.

The hysteria of the 8% GDP growth story excited - in an unlimited way - to the stock market and the finance companies, four million investors, and segments of the media that covered the Incredible !ndia stories.

Like China, India needs to find a solution - a visible solution - that will take hundreds of millions of Indians up the economic ladder. And find a way to climb the quality-of-life ladder. Not an easy task. Particularly when you have terrorists and politicians to deal with. But there is a way.

India’s job creation - and higher economic activity - can be led by infrastructure. The building of power plants, roads, bridges, railway lines.

True to form, there are a lot of announcements of infrastructure projects including the plan to double up and invest USD 500 billion for the five year period ending March 31, 2012. Well, we are 30% of the way there in terms of time, but are we likely to achieve that target?

Not that infrastructure is an easy thing to start. If you build dams and power plants, bridges and roads, there are environmental and social issues that need to be considered. Rightfully so - otherwise these "costs" come back to haunt you exponentially in the future.

India has the challenge of dealing with federal governments, state governments, and local governments - and political parties of all shades of the spectrum. Each one "represents" someone - or something. Each voice demands to be heard.

So it is with this similar challenge of finding jobs for hundreds of millions that China and India will write - and should write - their economic policy.

As countries, they begin from very different starting points. But, let there be no mistake. Neither China nor India can save the world - they first need to save themselves.

It is the failure of the "greed-capitalism" which has forced both countries to look within and start the more difficult work of building truly wealthy societies. And not be distracted by rankings and labels linked to market cap.

So - with apologies to the speaker from Shanghai - neither India nor China can save Capitalism or the global economy. But it is possible that the failure of "greed capitalism" will force both countries to look inward - and save themselves.

Courtesy: Ajit Dayal’s The Honest Truth, Equitynaster
http://www.equitymaster.com/ht/detail.asp?date=12/4/2008&story=1