August 13, 2012
Have you been following the murder trial in China, where a British businessman was allegedly killed by the wife of a man who was until recently tipped for political greatness? His fall from grace on corruption charges has been made far more vertiginous by the trial of his wife. You can’t say they don’t know how to destroy political opponents in China.
The trial, for those people who watch closely, is all about the power struggle at the heart of the Communist Party to see who is going to be the next Emperor and, possibly more importantly, who is going to be whispering in his ear.
As we wrote here in the column in June, the background noise to this power struggle is a slowing economy. The Communist Party need economic growth because, having dropped all their Maoist rhetoric, all they have is economic growth.
“Equality for all” has been replaced by the slogan of “prosperity for all” and if they don’t deliver they are toast. So the party will do whatever it takes to get economic growth going again. Unlike Mario Draghi, when the Politburo says it will do whatever it can, you can rest assured that it means it.
For foreign investors, who should be mindful of the quip that “you can make anything in China except money”, the slowdown should be watched carefully.
As we pointed out here a few weeks back, the economic evidence in China is screaming a sharp contraction.
Last week, we saw China’s export data for July which makes the “slowdown” there look like something else: a collapse of the export-led economy. Outbound shipments grew by just 1 per cent in July, after an 11.3 per cent rise in June.
Meanwhile, in the domestic economy, new loan growth for July was 540.1 billion yuan ($85 billion), compared with 919.8 billion yuan in June.
What is interesting is not so much that a supply-side, investment-driven boom may be coming to an end based on an inability to sell large quantities of everything to everyone because everyone doesn’t have the cash any more – what is noteworthy is the impact Chinese economic data are having on the rest of the world. Following the news, stocks in Tokyo, Hong Kong, Shanghai and Mumbai all fell back. European bourses are down too as are American ones.
But we shouldn’t be too surprised by this reaction. After all, China is the world’s most populous country, fastest-growing major economy, largest manufacturer, second-largest consumer, largest saver. It is also the US’s banker and the world’s largest holder of money, with foreign exchange reserves of $3.2 trillion (more than double those of Japan and three times those of the EU).
A major slowdown there – which is now clearly coming – will have serious ramifications for asset prices all over the world. It will be particularly serious for commodities whose prices (with the exception of food prices spiking up now due to the drought in the US) have been buoyed up by Chinese demand for the past few years.
Of course the most destabilising aspect is the politics of a slump in China. We are talking here about a country with 1.3 billion citizens. The problem for China is that we, that’s the rest of the world, are not buying. Chinese exports fell by 7.6 per cent in July and exports have fallen for three out of the last four months. Producer prices are falling too and the trade balance in July was $25 billion as opposed to $31 billion in June.
Looking out from China we see that manufacturing output in India was down 1 per cent, too and in Brazil output is down 4 per cent. In Europe, the Bank of France has admitted that the economy there is contracting.
In Germany, industrial orders are down, and now the country runs the risk of an inflated local economy driven by hyper-low interest rates, but a fall in the muscular side of the German miracle, the industrial sector.
Taking all this together, we can see that the global deflationary trends are broadening and deepening. So what should we expect next?
This is where we come back to last week’s article about the reaction of central bankers to all this. We spoke of the “risk on” and “risk off” trade. These are terms used to describe the reaction of central bankers and the investors who watch them to slumping growth. The minute we see economic weakness, major central bank slash rates but it remains to be seen whether all this cash finds its way into the real economy or merely finances yet more short-term rallies in financial markets which peter out.
So we can be sure that the Chinese Politburo is standing by with an avalanche of printing-press money. But will it work? Or will it, like so much of the other monetary stimulus, evaporate in another bubble in asset prices somewhere, enriching hedge fund managers and bankers but having precious little impact on growth, let alone society?
In China, we know that the miracle was investment-led. Anyone who has been there will know of the mega-sized building projects and the thousands of Western firms there – few of whom have made any money. But it is all investment. When investment falters, cutting interest rates doesn’t help you, and may actually may make things worse – if it leads to more investment it will lead to more overcapacity, falling property and asset prices and bankruptcy. So we can expect a new sea of cheap money washing over the world’s financial market, this time for a source that used to be the key saver.
With more European problems in the autumn, Spanish short-term yields are up above 4 per cent again this week, the US election in the balance and now with a slump in China, we are in for a rocky six months to Christmas