Today I continue with my examination of the three other Central Banks that need to pick up the monetary expansion baton from the Federal Reserve.
China is a little different from the European Union and Japan in that it does not rely as heavily on monetary expansion. Their command economy allows them to use both fiscal and monetary policy in conjunction to steer their economy. Theoretically this is also available to developed nations, but due to the large debt burdens of most governments, policy makers have been reluctant to use fiscal policy as a stimulus tool except in dire circumstances.
Over the past decade, China’s ability to command their economy has created a mistaken belief that government officials could dial whatever growth was needed. This created an over confidence that China’s economic miracle was never going to end.
Of course we all know that “this time is never different.” Sometimes when the trend goes on as long as it did in the case of China it shakes your faith, but it always ends the same way.
Last year China introduced an economic rebalancing program that shifted their focus away from export growth. This has caused the much over hyped “Chinese economic miracle” to come to a crashing halt.
I am quickly skimming through how we got here because I am more interested in where we go from here. Have a look at this chart of China’s Year over Year % GDP growth. It does a good job of demonstrating the “economic miracle” of the 2000s, along with the 2008 credit crisis and subsequent bounce, and finally the recent surprising slump.
China GDP YoY % Change</a> </div>
Over the years I have been what could be kindly referred to as a China skeptic. I have been very sympathetic to famed short seller James Chanos’ opinion that there has been a tremendous amount of mal-investment in China.
However over the last few months I have been taken aback by the complete 180 degree shift of investors’ attitude towards China. Whereas it used to be that investors believed China could do no wrong, it now seems that they think China can do nothing right.
There is good reason for their pessimism. Lately the numbers coming out China have just been terrible. According to ZeroHedge:
First-quarter growth in almost all Chinese provinces was below their annual targets, according to local media, with the most concerning data from resource-dependent and manufacturing-heavy provinces suffered the sharpest economic slowdown in the first quarter as the government pushed to tackle excessive factory capacity and pollution.
As Reuters reports, the fastest growth regions are Chongqing, Guizhou and Tianjin and all saw growth drop significantly. Specific provinces affected by the government’s reforms include Inner Mongolia, which provides one third of the coal supply in the country, saw GDP growth drop to 7.3% in Q1 from 9.9% a year earlier; Shanxi, a major coal producing province, which saw growth tumble to to only 5.5%; and Hebei province, the nation’s top steel producer, collapsed to only 4.2% in the first quarter of 2014 from 8.2% in the previous quarter. It seems the sum of the parts is anything but the same as the whole.
The costs of the economic rebalancing are weighing heavily on the Chinese economy.
The Chinese government had been allowing their currency to steadily appreciate over the past few years, but since the recent economic stutter started, they quickly allowed the currency to plummet.
CNY rate (higher rate means weaker Renminbi)</a> </div></p>
Some market participants view the recent currency depreciation as a sign that things must be much worse than the government is letting on. Weakening the currency is the classic response to a severe slow down in manufacturing.
I am not as fussed about the recent currency depreciation. At the end of the day, the world does not have enough growth. We are entering into an era where we are going to see more and more competitive devaluations to “steal growth.” The Chinese have been doing this the past two decades – we can’t expect them to stop at the exact time everyone else is ramping up the devaluations.
Have a look at this chart of CNYJPY cross rate:
CNYJPY Cross Rate</a> </div>
The Chinese Renminbi has been steadily appreciating against the Japanese Yen since 2012. There is only so much appreciation that the Chinese are going to take before they resort to the same devaluation tactics.
Do not get me wrong – I don’t think that the recent weakening of the Chinese currency is a positive sign. But I do believe that it is a natural result of the new growth starved global economy.
There is no way that the Chinese are going to be the outlet valve for the rest of the world to export away their deflation.
The Chinese government is gingerly trying to rebalance away from export led growth at a time where global economic activity is slowing. At the same time, the Federal Reserve is attempting to navigate their way through their own removal of monetary stimulus. This is not the stuff of heady economic global growth.
The real question is whether the Chinese will blink? Will they abandon their rebalancing and return to their old ways?
The government understands that their economy is slowing down, but instead of stimulating export led areas of the economy, they are trying to focus their efforts on different areas. From the WSJ:
BEIJING—China’s central bank said Tuesday that it will reduce the share of deposits that some rural lenders need to set aside as reserves, in a move aimed at giving a lift to economic growth.
The People’s Bank of China cautioned that the move doesn’t suggest a change in monetary policy but said it would increase lending to the agricultural sector.
The reserve-requirement ratio, or the percentage of deposits that must be kept as cash with the central bank, will be cut by 2 percentage points for county level rural commercial banks and trimmed by 0.5 percentage point for rural cooperatives, the PBOC said in a statement on its website.
Beijing said last week it would lower the reserve requirement ratio for some qualified rural banks, but it didn’t provide details.
After the cut, which takes effect Friday, the ratios will stand at 16% for rural commercial banks and 14% for cooperatives, according to the central bank.
It also added that the reserve requirement for these two types of lenders could be further reduced by another percentage point if a certain proportion of their funds are lent out locally. The central bank didn’t elaborate.
“This will boost support for agriculture…and strengthen financial assistance to the real economy,” an unnamed spokesman of the central bank said in a separate statement. But the spokesman said this doesn’t mean a change of the bank’s “prudent” monetary policy and the move “will not affect overall liquidity in the banking system.”
Unlike an across-the-board cut in the bank reserve ratio, which would affect key urban areas, the move won’t have a huge impact on the overall economy.
Nomura economist Zhang Zhiwei estimated that the reduction would make 80 to 90 billion yuan ($12.9 billion to $14.5 billion) available for lending, a sum that would be “effectively insignificant given the size of the economy.”
But he said the move is a signal that the government is concerned about slowing economic growth.
China’s economic growth slipped to 7.4% in the first quarter from a year earlier. In the fourth quarter of last year, the economy grew 7.7%. Economists have been cutting their estimates for the nation’s full-year growth, with some predicting the world’s second largest economy won’t reach its target of about 7.5% growth for this year.
Earlier this month, the government unveiled a series of growth-support measures, including accelerated spending on railways, more funds for slum clearance and tax reductions for smaller businesses, in a bid to help the economy.
Meanwhile, China’s State Council, the country’s cabinet, said Tuesday that it will let qualified rural financial institutions issue preferred shares and other capital instruments to help them replenish capital bases.
It is my belief that China will not let their economy slip much further from here. We are going to see more and more stimulus measures such as this one above in the months to come.
I know that markets are bigger than governments. I know that a government’s ability to “dial” growth over the long run is very much illusory. I understand full well how much mal-investment has occurred during this supposed “Chinese economic miracle” of the past decade.
But I think the tide has fully gone out in terms of investors’ attitude towards China. Recently I am constantly bombarded with a steady stream of research about how bad things are in China. The “Chinese economic miracle” has been thoroughly abandoned.
My original goal of this series of posts was to determine which of the three other major Central Banks would blink. Yesterday I wrote about how I thought the chances of the ECB doing anything more than talking was low. As for China, they are the complete opposite – they do very little talking preferring to let their actions do the speaking. I think that the recent min-stimulus program and the deprecation of their currency over the last couple of months has shown that they are not going to idly sit by and allow their growth to spiral lower uncontrollably.
I fully expect that if their economy continues to slow that the Chinese government will increase their stimulation efforts. I also expect it will surprise many market pundits with its efficacy. I am going to fade the overwhelming pessimism regarding the inevitability of a Chinese economic accident.