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
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