Sunday, May 20, 2007

Chinese Godzilla

Yes I know, the correct cliche is "Chinese Dragon", but Godzilla seems more appropriate given the massive imbalances and asset bubbles that are growing - accelerating - in China with increasing risk for global markets and economies. The Shanghai and Shenzhen stock exchanges are the headline story for even the most casual US market watchers tuning into CNBC: Chinese stocks have increased by a factor of almost 4x since the beginning of 2006 while Mr. and Mrs. Wang and family have taken $9 billion out of the bank to invest in stocks (opening new brokerage accounts at a rate of more than 300 thousand per DAY). The CSI 300 trades at close to 45x earnings though it must be said that earnings are growing very rapidly - which brings us to the next bubble/imbalance/monster: the economy.

Although there was an ever so slight deceleration of growth towards the end of last year, it now seems clear that economic growth and investment in China has reaccelerated this year. Any rebalancing of growth away from exports and heavy industry to consumption is not yet apparent. The central government has tightened monetary policy numerous times via increased reserve requirements and rate hikes - the latest increase in one year deposit rates to 3.06% and loan rates to 6.57% - which has accomplished exactly nothing. Which brings us to the third massive and accelerating global montrosity: the trade suplus. Stephen Green of Standard Chartered writes in BusinessWeek that the surplus will hit $400 billion this year, up from about $250 last year - this is a higher number than most any other economist and is a shockingly large figure. His basic point is that he doesn't see any slowing in investment, i.e., heavy industry capacity increases (he estimates 60% of China's exports are capital-intensive). If Mr. Green is correct than China's foreign exchange reserves will grow to $1.6 trillion by year end.

My view is that the Chinese authorities are getting very little sleep these nights - they appreciate very well the problem and the consequences for not getting this monster calmed down. They will continue the "slowing by a thousand cuts" approach until something finally gives. This much seems certain. What is not at all clear is how bad the effect will be once the world sees Chin-zilla (not very good I know, I'll work on it) beginning to slow. Stock markets don't tend to quadruple and then tread water. And the US is going to hit China with some trade protections - the only question is how much. The larger the monster grows, the greater the measures the other monster (Congress) will enact. Not only is the result unknown but the stakes are just so high. The sheer size of this thing is truly breathtaking and I can't help but worry that the resulting collapse/panic/slowdown - will be equally massive.

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