 China at a
Crossroads
David Chapman
November 30, 2004
Over the past twenty five years the Chinese economy has been
nothing short of miraculous averaging roughly 9% per year. In
the process China has become one of the prime economic engines
of the entire world. During this period the Chinese economy went
from a totally command economy to one that maintains many of
the elements of a command economy but through reforms has opened
up more than anyone ever thought it would.
Despite economic reforms China is still ruled by one party and
dissidents are still subject to arrest. But with numerous economic
reforms and freedom has come the demand for more personal reforms,
freedom and democracy. The current system has taken on more the
characteristics of fascism (marriage of state and capitalism)
then it is the old communist model. But growth and those who
benefit from the growth has been very uneven. The main benefactors
have been the coastal provinces and urban populations. China
has seen spectacular urban growth over the past decade but the
population is still largely rural. And it is the rural population
that still makes up about 60% of the population that has not
as yet benefited from the growth. The result has been that unemployment
remains quite high particularly in the rural inland provinces
and there remains from the old days numerous inefficient state
industries.
Still as The Economist points out the growth is starting
to make some inroads into the inland provinces (China's growth
spreads inland - The Economist, November 20-26, 2004).
Growing unrest in a number of the inland provinces keeps pressure
on the central government to ensure that economic growth becomes
more evenly divided. We are reminded that Chinese revolutions
(Communist, Boxer) were largely economic in nature due to huge
inequality.
But one thing that has been amazing with the incredible Chinese
growth of the past quarter century is that no major economic
slowdown has occurred. The longer it goes on of course the higher
the risk. We are all reminded that over that same quarter century
of spectacular Chinese growth we have had the Japanese property
and stock market bust (1990-1995), the Asian financial crisis
(1997-1998), and the Internet/Tech bust (2000-2002). So to say
it can not happen is pure wishful thinking.
Since 2001 the Chinese have embarked on a huge spate of construction
projects (including the 2008 Olympics) many of them quite speculative,
financed by money from the Chinese banks where risk assessment
seems to be merely a word in the dictionary. Chinese banks, according
to The Economist, are just conduits to throw money
into government projects and state-owned companies, with little
regard for risk or profits. According to a recent article in
Asia Times (Crash landing coming for China - Jack Crooks, November
12, 2004) the Chinese banking system is virtually insolvent.
At the end of 2003 outstanding loans to GDP was 145%, the highest
ratio in the world. Bad debts at 40% are also the highest in
the world. Crooks describes Chinese bankers, particularly at
local branches, as being unable to tell a good loan from a bad
loan. Pay is dependent on asset growth not whether you make a
profit or not.
This speculative bubble is an accident waiting to happen and
belatedly the Chinese have begun to realize that something has
to be done about it. Ergo the recent increase in interest rates
for the first time in almost a decade and a tightening of administrative
controls. It may be that all of this is too little too late and
an economy that is becoming an accident in waiting may hasten
its way there. China's economy is very dependent upon increasing
amounts of capital to finance the manufacturing, construction
and infrastructure and without this feed the economy will stall.
The service sector is the smallest of any major economy and consumption
is also the lowest of any major economy. Household debt has grown
very rapidly in the coastal provinces but remains very low in
the inland provinces.
China, like Japan before it, has become a major exporting country.
And its major exporting partner has been the United States. It
is a very circular relationship. Again as Crooks drew so neatly
in his November 12 article China as global manufacturer ships
its low priced goods for the US consumer and the US Dollars that
come back to China makes them then a capital supplier wherein
they help finance the huge and growing US deficits in trade and
budget by buying US Treasuries thus subsidizing the US consumer
by allowing the Fed to maintain low interest rates. Growing consumer
demand then fuels the final bit of the circle by spurring further
investment in China.
On paper it looks great. Trouble is that is has also fueled the
debt bubble in the US and spurred the investment bubble in China.
China is financing the debt bubble (along with Japan who together
make up the primary purchasers of US debt) while the reinvestment
back through the shaky Chinese banking system that knows no bounds
in what constitutes a solid investment is when you look at it
closer two bubbles that are accidents waiting to happen. The
Chinese have fixed the Yuan to the US Dollar. So the Chinese
have not suffered the deterioration in their US$ reserve and
investment portfolios the way the Europeans, Japanese and even
Canada have. But pressure is mounting on the Chinese from the
US to allow their currency to revalue higher against the US$.
The Chinese are resisting and if they do it, and they probably
will, they will do it in their own good time. The hiking of rates
and tightening of administrative controls are probably a first
step. The second step may well be to widen the trading band for
the Yuan from the current miniscule 0.3% to a 3-5% range (Asia
Times - China readies to pull the peg - November 20, 2004).
Everyone is caught in a catch 22 with the falling US$. A falling
US$ makes the exporting countries currencies more expensive thereby
putting pressure on their exports and then they in turn want
to stem that flow by buying more US Treasuries to continue to
finance the US debt bubble. As the US$ goes down the value of
their US debt holdings falls also increasing pressure on them
to dump them but that in turn will just mean that the US$ falls
even faster. Japan, according to recent statistics has slowed
their purchases of US debt but they are still the largest purchaser.
China is trying to diversify away from US debt by converting
into Yuan and or looking for purchases in other currencies or
investments in other countries. China also wants to increase
its official gold holdings which would is as well another way
of diversifying its reserves. In some ways a stronger Chinese
currency would be positive for them as it reduces the cost of
the commodities that they use. Remember with a fixed Yuan to
the US$ the price of oil and an whole host of other commodities
is rising as well. But in the other catch 22 if the Chinese economy
was to slow and the demand for these commodities fell then there
could be a commodity price crash as well. How to lower the US$
and raise the value of the Yuan without causing a global economic
crash? That is the question. And may we add that in the case
of the US, no one ever devalued their way to prosperity.
And as if that isn't enough China with its huge growth has now
become the world's second largest user of oil and the demand
should just keep growing as more and more people buy cars as
a result of growing incomes. That makes oil a strategic commodity
for China and they are making it clear it is. With the US also
long declaring that oil is a strategic commodity and the fact
that two thirds of the world's oil reserves lie in the dangerous
mid-East another economic clash could be lying in the wings.
Recently China secured a huge $70 to $100 billion deal with Iran
for oil. Given all the rhetoric and saber rattling between Iran
and the US over Iran's nuclear weapon ambitions, any solution
to that just got more complicated. The military solution to the
problem may have hit a brick wall. Ditto for a military solution
to the nuclear weapon ambitions of North Korea, where that is
just too close to China for comfort.
China is at a cross roads. And if China is at a cross roads so
to is the rest of the world because if China's attempts to try
and bring itself down with a gentle landing and it fails turning
into a crash landing then it will impact the rest of the world
as well. But the Chinese economy is young and with 1.2 billion
people the growth possibilities are huge. So even if China were
to have a crash landing it would be cleansing and they should
emerge from it stronger. But we are not so sure how a debt laden
country such as the US will emerge from a Chinese crash landing.
That could be a completely different story.
Spectacular rise in 2003
was met with a very sharp correction into mid-2004. The current
up-wave remains short of the highs. A failure to make new highs
would suggest that the collapse in 2004 was corrective in nature
and this is the B wave up. A C wave could take us to new lows
or the correction could be more complex in nature. Given that
China has raised interest rates and that a slowdown in their
economy has not as yet happened despite the enthusiasm for China
we would be cautious on purchases here. Any return back under
the 200-day moving average should put everyone on the sidelines.
Given the speculative investment fervor in China today and the
probability of an upward revaluation of the Yuan the Chinese
stock market could remain weak for some time.
David Chapman
Email: david@davidchapman.com
Note: Charts created using Omega TradeStation or SuperCharts.
Chart data supplied by Dial Data.
 David
Chapman is a director of the Millennium Bullion Fund.
The opinions,
estimates and projections stated are those of David Chapman as
of the date hereof and are subject to change without notice.
David Chapman, as a registered representative of Union Securities
Ltd. makes every effort to ensure that the contents have been
compiled or derived from sources believed reliable and contain
information and opinions, which are accurate and complete. Neither
David Chapman nor Union Securities Ltd. take responsibility for
errors or omissions which may be contained therein, nor accept
responsibility for losses arising from any use or reliance on
this report or its contents. Neither the information nor any
opinion expressed constitutes a solicitation for the sale or
purchase of securities. Union Securities Ltd. may act as a financial
advisor and/or underwriter for certain of the corporations mentioned
and may receive remuneration from them. David Chapman and Union
Securities Ltd. and its respective officers or directors may
acquire from time to time the securities mentioned herein as
principal or agent. Union Securities Ltd. is an independent investment
dealer and is a member of the Toronto Stock Exchange, the Canadian
Venture Exchange, the Investment Dealers Association and the
Canadian Investor Protection Fund.
________________
321gold Inc Miami USA
|
