South China Sea First Test for U.S. Shift – Business Insider Article

Tensions are rising again in Southeast Asia as competing claims over the resource rich South China Sea push closer to boiling point. One would hope that countries in the region would take concerted action. That hope would be misplaced.

An increasingly militarized land and sea grab continues despite calls for peaceful resolution. With the U.S. in full Asian tilt, the South China Sea dispute is shaping up to be the first major test of its Pacific re-engagement. What the U.S. can or should do remains woefully undefined.

Full article available here.

Reading (and Misreading) China’s Economy

Reading (and Misreading) China’s Economy

A wave of articles and data have come out in the last few weeks on the current and future state of China’s economy. Like the Beijing air, there’s nothing clear about what’s going on in the world’s second largest economy, let alone where China may end up by year’s end. Sometimes it’s all blue skies, most other days it’s barely breathable.

CCB’s recent private sector survey dubbed the China “beige book” interviewed 2,000 businesses. According to Bloomberg the report focused on business aspirations painting a contrarian optimistic view. Other official figures, such as they are, indicated slight short-term improvements including low inflation, rising household incomes and a slight rebound in real estate prices.

These stand in stark contrast to the litany of negative economic news. HSBC’s purchasing manager’s index showing continued contraction from a shrinking base. China’s official PMI showed slowing growth bordering on contraction. Local finances are rising to unstable levels as city and provincial officials, eager to prove their compliance with national growth targets, took on enormous debts apparently with no way to pay them back. Industrial production figures, electricity usage, and stock market performance all point to harder times ahead. Add to that weak retail sales and price wars and the slowdown looks deeper and more significant.

Chinese government officials, most notably Premier Wen, consistently warn of more problems to come. Two recent China bank rate cuts highlight where economic policymakers stand. Time to re-start the lending engines, but the quality of that money flow remains questionable. There has been no fundamental reform of the banking sector (see “Red Capitalism” by Walter and Howie for a book length analysis or Michael Pettis’ blog for current warnings.)

One problem with any soft data survey in China is the tendency for those interviewed to inflate or underestimate their sense of where things are and where they’re going, depending on the climate. Information is political currency and the control of that currency like the yuan is a complicated business. For economists accustomed to watching the hard numbers more than than aspiration of consumers or businesspeople the obscurity of statistics is particularly acute. Anyone attempting to invest in a Chinese company is well advised to examine the first set of books, scrutinize the second and try to find the third.

This lack of transparency, and the desire to avoid the accountant’s incisive gaze has now shown up in Chinese companies delisting from U.S. stock exchanges because of the perceived onerous reporting requirements of regulators. Sinoforest with its “irregularities” ended up in bankruptcy. Moody’s reported 49 firms with increased risk a year ago and the questions keep coming with Hong Kong listed firms now ringing alarm bells. The U.S. is no stranger to scandal. Too bad the SEC never got around to investigating Lehman Brothers, but a familiar wind blows through China’s financial markets these days too similar to the schemes and funny money business of Wall Street.

Another problem is the tendency to make sweeping claims from short term data. One or two months does not a trend make, but eager media cycles and investors selling their latest decisions to move money in or out constantly claim the higher ground. That the Shanghai composite index is down 15% from its May 2012 high either means investors are fleeing a sinking ship, or the market is attractively undervalued.

Conversations about hard vs. soft landings miss the main point of China’s rise and recent slowdown. Years of muddling through after such wild growth may do just as much damage as a U.S. style banking crisis. Either way the economy is in for a rough ride. Watch the middle class for signs of where China is headed. They’re the country’s real future.

Photo: Shanghai Shopping, (c) Brian P. Klein, 2012

The Week That Was (and Wasn’t)

Walking Backwards into the Future – In a 5-4 Supreme Court ruling upholding President Obama’s healthcare bill the U.S. finally joined the rest of the developed world of 60 years ago with universal coverage. China joined the space world of 50 years ago with a successful orbital docking mission, including a safe return to earth of three astronauts and China’s first woman in space. Read more »

Blinded by the Euro Light – Hopes for a breakthrough on several fronts in the global economy came to naught this week. EU leaders met, and discussed, and discussed some more. Solutions to the spread of financial distress affecting France, Italy, Greece, Spain, and Cyprus appeared at hand. Markets rallied after the European Stabilization Fund was announced which would buy sovereign debt and lend to banks across the EU. The compromise solution avoided the more prickly bailout mechanism of direct loans to financially unstable countries. Have any of the foundational problems changed? Sadly, no. Read more »

Financial Deception, Not Just for Wall Street Anymore – Were the financial mess in Europe not enough to make people wonder about the global economy more banking scandals erupted, this time in the UK. Collusion on bank-to-bank lending rates first discovered at Barclay’s are now suspected across a number of other banks. Not only do these rates directly impact financial performance, they are supposed to be a bell-weather of economic activity. If the instruments of market temperature-taking are faulty then a host of undiscovered ills will erupt yet again in crisis. Read more »

A Tentative Peace, and More War – China and the Philippines withdrew their ships from the Scarborough Shoal after a tense standoff in contested fishing waters. Wars have started over lesser disagreements. There’s no end sight to the cycle of provocation and pushback. ASEAN has failed to act – non-claimant states are loathe to risk their economic relations with China by siding with their southeast Asian counterparts. And China is quick to react to perceived slights using import bans including Norweigan fish after a Dalai Lama visit (no more smoked salmon from you, literally). Philippine fruit was the latest during the recent stand-off. The Chinese government also banned tourist travel (yes, travel agencies still need government approval to organize trips from China to other countries). Read more »

If you’d like to receive email updates from Klein’s Commentary connect with email, Twitter or Facebook.



Mid-Day Note: Global Economic Data Disappoints

Mid-Day Note: Global Economic Data Disappoints

U.S. economy still lags.

Today’s U.S. housing and consumer confidence figures failed to signal a real economic rebound. This after Moody’s downgrades of fifteen banks last week, including Goldman Sachs, and earlier Federal Reserve data* showing U.S. household net wealth plunging over 40 percent between 2007-2010. That’s an entire generation of wealth creation gone in three years. On a slightly positive note net wealth has been growing slowly since then, but for whom? Mainly shareholders and executives. Corporations continue to sit on cash ($1.7 trillion give or take) while the middle class, hit hardest by the downturn remains worst positioned to recover.

The temperature continues rising on a host of ills begging for resolution (jobs, insurance, income gaps), but as election season shifts into full gear expect more political paralysis in Washington, not less. Still, some growth, any growth, is better than contraction even at a paltry 1.8%. Lower gas prices may pump a few extra dollars into pockets over the next few months. Major concerns of course remain. Where will growth emerge if consumers continue to face pressure from all sides – stubbornly high unemployment, marginal home price increases, expiring tax breaks and soaring healthcare costs. Expect a long, hot summer.

Europe – Cyprus and Spain join the bailout line.

Moody’s downgraded Spanish banks in a widely recognized crisis of financial confidence. Now one of Europe’s larger economies officially joins the bailout que. Add Cyprus’s estimated 5-10 billion euros, a pittance compared to Greece, and Europe’s southern rim continues unravelling. Brussels won’t yield money without constraints. The only question left, at what cost in the short term versus broader integration later. The focus needs to remain firmly on the moment as the European Union will need plenty of time to hash out new monetary rules among its 17 member countries and 23 official languages.

Japan – Nuclear power returns but jobs may not.

Nuclear plants are coming back online absent energy alternatives (including a fragmented electrical grid and untapped geothermal resources). That will at least avoid production shutdowns that hobbled 2011 electronics and automotive manufacturing. Tepid recovery following last year’s disaster remains on track, but a track to where? Longer trends still point downward. Major manufacturers are off-shoring in droves, responding to light domestic demand, a troublesome exchange rate (making exports exceptionally expensive for overseas buyers), and greater growth prospects elsewhere. With all three of the world’s traditional growth engines stalled or sputtering, sources of new growth remain a mystery.

China – Slower growth than expected.

Serious headwinds continue to mount in China’s struggle to maintain history-defying growth. HSBC’s June flash purchasing manufacturer’s index fell to 48.1, it’s eighth consecutive month of contraction staying below the critical 50 mark. Accurate statistics continue to be problem, but if electricity consumption and coal inventories are any gauge, especially in China’s southern production heartland, then a slowdown has been building for some time. Power generation is barely growing as it approaches early 2010 lows, and this time absent a major global economic shock like the U.S. financial crisis. Strains in Europe alone don’t account for this slowdown. Chinese stimulus efforts are expected to fall far below their previous $550+ billion injection during the leanest years (2008-2009). Officials know that only so much demand exists for infrastructure and construction projects, their preferred stimulus sectors of the past.

Bottom Line:

Tepid U.S. recovery continues but rising risks suggest more slowing ahead. Europe’s ills are the near term weight, but China has a long way to go towards structural change and real consumer-driven demand. With their own power transition incomplete until the end of the year don’t expect dramatic upside surprises any time soon. If/when politicians on any continent finally resolve to get more money into the pockets of the middle class, then recovery prospects will finally brighten.

* For Federal Reserve household wealth data see:

Photo: Brian P. Klein
China’s Foreign Banking Troubles

China’s Foreign Banking Troubles

In James McGregor’s 2005 book “One Billion Customers” eager investors were warned about the pitfalls of doing business in China. Many U.S. firms, mostly large and concentrated in the hotel, machinery, commodities, and higher-end consumer goods segments have overcome these challenges and done spectacularly well. Financial firms on the other hand have hit a policy wall and will continue to face difficulties for the foreseeable future.

The potential envisioned by foreign banks, including retail branches, ATMs on every corner and healthy loan yields on prime construction projects never materialized, even with China’s double digit growth rates. Bloomberg reported recently that foreign banks hold a paltry 2% of total assets in China, despite clear obligations to open the financial sector following a 2001 entry into the WTO. That unequivocal obligation read:

“Upon accession foreign financial institutions will be permitted to provide services without client restrictions for foreign currency business upon accession; local currency services to Chinese companies within two years [by December 2003]; and services to all Chinese clients within five years [by December 2006].” WTO press release, 2001

By 2004 problems were already surfacing yet an IMF working paper wrote them off to “primarily technical difficulties, and not a broad pattern of non-compliance.” While China has benefited greatly from its WTO membership, it still plays pauper when confronted with its own lack of opening. For foreign banks the dream of riches pales in comparison to the reality of making back only $10 billion on their $60 billion in investment.

One of the major impediments to greater opening involves the interdependence of state owned enterprises, state controlled banks and government growth policies. Essentially the current Chinese banking system acts as the financial proxy for Communist Party economic policies. To develop “national champions” in telecommunications or oil and gas that can compete internationally, for example, state-owned banks dutifully comply with low interest loans to state-owned enterprises. If those companies run into trouble the loans may be rolled over or written off entirely.

Small and medium sized enterprises, were they even to qualify for loans, do not enjoy the same luxury. When banks themselves ran into trouble they were bailed out by the government. Several years later they re-capitalized through IPOs.

Funding for these policy-based loans come primarily through deposits of the general public which has precious few choices for their hard earned yuan (real estate, under the mattress or the banks). At current rates they lose money every month that inflation tops savings rates.

Recent government policies to close the lending/savings rate gap will be a small boost to consumers. If real competition existed, and foreign banks operated on a level playing field, market-based rates would rise through competition. Further financial sector reform would be a key sign that policymakers are committed to transition from state-led growth to a consumer-driven economy.

In the near-term liberalization remains highly unlikely. Government planners remain convinced that economic levers like the banks should remain firmly in their hands. Foreign companies don’t appear eager to lobby their respective governments to initiate WTO cases fearing that might jeopardize current and future business, despite the constraints.

For now they’ll fare better with private wealth management services. That’s a booming industry with longer-term growth prospects.


Photo: Brian P. Klein – National People’s Congress, Beijing.
Commentary: The Slower Road in China

Commentary: The Slower Road in China

There’s an unusually cool breeze blowing from across the Pacific as spring gives way to an uneasy summer. China’s stringent government efforts to reign in an overheating economy marked a welcome pause in the hottest growth story of the century. The depths of the slowdown, however point to a less manageable set of problems after years of state-led economic development.

The next few months will reveal whether the central government can really turn the growth taps on and off at will. Quality now matters far more than quantity alone. Following through on much needed (and talked about) reforms to spur domestic consumption will create a more stable environment. Maintaining the status quo will not. Either way, China’s economy is changing and so is the world outside. (Excerpt from China-U.S. Focus. Full article here.)

Graphics credit: China-U.S. Focus
Xi Jinping Business Luncheon

Xi Jinping Business Luncheon

The crowd of 600 or so business and diplomatic leaders snaked their way through the security lines at the Marriot Wardman this morning while flag waving supporters gathered outside. Henry Kissinger set the geopolitical context with a reminder on the need for greater U.S.-China ties. The alternatives would be disastrous for both, he emphasized. In a nod to changing times he mentioned the “old” world of international affairs within which he grew up and operated, a world where states marked territory and competed for influence. Those days are passing and the problems facing both the U.S. and China require cooperation not conflict, he said.

Xi’s thirty-minute or so speech contained no major policy announcements. Long on positive trends in U.S.-China relations and the start of a new era (important signaling for possible future changes) he went on at length of his affection for Iowa and reconnecting an American to old friends from her youth, now ninety years old, in China. The crowd listened politely, but there was no mention of resolving many of the trade tensions that plague the relationship.

Xi said both of our countries will continue to work closely together. The U.S. should recognize Tibet as part of China (an unusual talking point for this crowd), but human rights are an important issue to discuss. The trade deficit can be eased if the U.S. would allow more high-tech exports (a common talking point for the last five years or so).

Overall impression – A seasoned politician at ease with speechmaking, but offering little insight into where China is headed. His visit is clearly meant to renew and deepen relationships, not promote specific policies. It would be politically unwise for him to step out on a limb until the political transition is complete later this year and he consolidates his allies into key positions. Look to early-mid 2013 for signs of any new direction.


Photo: Public domain.

Can China Lift Japan Out of Recession?

Hopes are high and rising that a near-term China recovery, fueled by an estimated $587 billion stimulus plan and massive bank lending, will be a boon to Japan’s ailing export sector. This new demand is expected to lift China out of recession even before the United States and Europe recover. China’s stimulus, however, is neither large enough nor necessarily supportive enough of foreign imports to have a significant short-term impact on Japan’s rapidly deteriorating economy.

Full article.