A Chinese slowdown might rescue $ for a while

“Oh what a tangled web we weave, when first we practice to deceive”
Sir Walter Scott.

“You know, you are like Jagjit Singh’s ghazals,” she said, as soon as I made myself comfortable on the bean bag with a glass of green tea in my hand, after pretending to work all day in office.
“Ghazals of Jagjit Singh, eh?” I asked, sipping the tea rather loudly to irritate all the ‘etiquette’ in her.

“Yes. Initially they all sound different, but having heard them over and over again, they all sound the same.”

“So? Shouldn’t you be moving to Pankaj Udhas now?” I quipped. “But he hasn’t sung as much as Jagjit Singh has, so maybe there is a problem there.”

“You and your silly jokes. What I meant was I am bored and need some change from the usual,” she explained, rather dramatically.
“So you could have just said that!”

“Hmmm. I could have. But that wouldn’t have been fun at all. So tell me, what do you think about China?”

“Ah. The Middle Kingdom, as they used to call it.”

“Yeah, that I know. But isn’t it interesting that even when the entire world was going bonkers last year, they managed to grow their gross domestic product grew by 8.7% to $4.9 trillion. Isn’t it?”
“As Aaron Levenstein once famously said: “Statistics are like bikinis. What they reveal is suggestive, but what they conceal is vital.”

“Some firang said that? And I had thought, for once, it was an original Siddhuism,” she remarked, rather surprised.

 “What is important is to see where did the growth come from. The growth was 8.7%. Of this, 8% growth, as per China’s National Bureau of Statistics, came from investment which included infrastructure investment. And how did that happen? The Chinese government pushed all the big state-owned banks to finance as many infrastructure projects as they could. This led to their loans doubling to 9.6 trillion renminbi (the Chinese currency) or $1.4 trillion during the course of the year.

Now, these loans amount to around 28.5% of the total GDP of $4.9 trillion. But they also include the loans that would have anyway been made during the course of the year, the government directive notwithstanding. If we adjust for that, this stimulus to the economy in the form of more bank lending came to around 15% of the GDP, which is a huge number. As Bill Bonner wrote in a recent column “The China story is largely a stimulus story too. China’s stimulus, compared to GDP, is the world’s largest ever — four times the size of America’s stimulus programme.””

“All that mumbo-jumbo is fine. But difficult times do call for desperate measures. Don’t they?” she interrupted.

“Well, not always. What happens with such an easy lending policy is that money is not always invested the right way. The Financial Times did this rather interesting piece on empty towns in China. Now let me read out the opening of that story to you,” I said, reaching across for my laptop, and began.

“Chenggong is a new town near Kunming, one of the main cities
in the southwest of China. Construction started in 2003 and the results are now apparent in 13 immaculate local government buildings, each clad in marble tiles. A high school boasts an impressive indoor swimming pool and several of the region’s universities have built large campuses. Pristine high-rise apartment blocks stand in rows, their new windows glinting in the subtropical sun. The one drawback: at the moment, Chenggong is almost completely empty. Its wide streets are all but bereft of traffic, a bank branch has no customers and leaves collect in the foyers of the municipal offices.”

“So? Governments are supposed to develop infrastructure, aren’t they?”

“Yeah. But at times, governments go overboard, building things that aren’t really needed and calling that growth. That seems to be happening in China. As Bonner wrote in a recent column “There are about five times as many rivers in the US and five times as many cars… but China now has nearly as many bridges… three quarters as much road surface.”

This infrastructure that is being created needs to generate revenue to pay off the debt that has been taken from banks to create this infrastructure in the first place. But excessive infrastructure does not always generate revenue. Imagine what will happen to all the banks if these loans start to go bad.

Also, this easy-loan led growth cannot continue forever. This easy-money policy of the banks induced by the government has led to land prices going through the roof. Data from Standard Chartered suggests that the average land price in China went up 106% last year. In Shanghai, it went up by 200%. To control this price inflation, starting mid-January, banks have been asked to go easy on lending and that should help.”

“So the pessimist in you is saying that Chinese banks will go the Wall Street banks way?” she asked.

“Not at all. The Chinese foreign exchange reserves currently stand at $2.4 trillion. So that money can always be used to rescue the banks if their loans start go bad. The point I am trying to make is that this forced-investment led growth cannot continue forever and it needs to slow down. And when that happens, the Chinese GDP will not grow at the astonishing rates that it has been growing in the past. If Chinese growth starts to slow down, all the commodity exporting countries will have a problem, given that China alone consumes 40% of the world’s copper, 47% of steel and 30% of aluminum. It is also the second largest oil importer in the world. If steel demand falls, the demand for iron ore also goes down, which goes into making steel. Now take the case of a country like Brazil. Iron ore accounts 25% of its exports to China and petroleum, 10%. What will happen to Brazil’s exports if Chinese demand slumps?”

“So you’re saying that it’s all interconnected.”

“Yeah. And all the firangs who are currently mouthing platitudes about emerging markets like India and China, will be the first ones to sell out of the stock markets in these countries once China’s growth slows down. And where will all the money go? It will first be converted into US dollars. The sudden demand for US dollars will shore up the dollar for a while. These dollars will then be invested in the perceived safety of US government bonds. This in turn will help the US continue borrowing the astonishing amount of money that it has been borrowing. It is widely expected that the US Treasury will borrow $1.6 trillion in 2010 and $1.3 trillion next year to finance its fiscal deficit.”

“Interesting, as always.”

“Yes Mam. And I think you are a bit like songs in the movies of Guru Dutt.”

“And what is that supposed to mean?”

“Songs in Guru Dutt’s movies don’t have any prelude to them. They start just like that!”
(The example is hypothetical)

References:
Zombieland, Bill Bonner, www.dailyreckoning.com, March 5, 2010
No one home, Geoff Dyer, www.ft.com, February 22, 2010
Optical Illusions, “Oil Shocks,” and China’s Headache, Gary Dorsch, www.safehaven.com, March 11, 2010
“And gold will be the last man standing”,
www.dnaindia.com, March 15, 2010