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.
 

 

 

Financial Deception, Not Just for Wall Street Anymore

Were the financial mess in Europe not enough to make people wonder about the health of the global economy another banking scandal 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 in crisis yet again.

JP Morgan’s escalating fiasco had CEO Janie Dimon chumming it up with the U.S. Congress, pleading ignorance, full of apologies and resolutions to never let it happen again. First it was $2 billion in trading losses, now they may run as high as $9 billion, or maybe “only” $5 billion. So far his talking point success (and deep banking connections in government – see ProPublica’s spot-on reporting)  staved off the ire of lawmakers and the threat of sweeping regulations. Win one for the PR department.

Will regulators in Europe or the U.S. ever make the fines fit the “crime”? If not, expect more of the same.

Back to “The Week That Was“.

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.

Even though the immediate money squeeze has been solved broader concerns remain. How do European countries orient themselves back to growth? Unless they succeed in upping their competitiveness both banks and governments will be in the pauper’s line , hands outstretched for another bailout. Spanish banks avoiding default is welcome, but that’s little solace for the 25% unemployment rate except, for the moment, to keep it from rising further. Will banks start lending to small and medium sized enterprises and stop making bad loans on real estate? Let’s hope so.

Back to “The Week That Was“.

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.
Are ETFs the New CDOs?

Are ETFs the New CDOs?

As if the wizards of finance hadn’t done enough already. Remember when collateralized debt offerings (CDOs) entered common usage? Mortgages were sliced up, repackaged, and re-sold into “synthetic” products barely resembling the underlying property on which they were supposedly based. Sounds a lot like how bologna is made. When the housing market went bust CDOs transmitted and amplified the effects of the downturn taking some venerable banks along with them. Now exchange traded funds (ETFs) are racing to take the place of their derivative cousins.

In the simple version an investor buys shares in a publicly traded fund that say indexes to the U.S. Fortune 500. As money flows in, the fund then buys actual shares of those companies and the investor owns a small percentage of that diversification.

Synthetic ETFs,  however have bet money on collections of other ETFs without ever actually owning the underlying stocks. The interconnected nature of the financial markets means that if ETFs stumble they not only affect the holders of those securities but ripple across the murky derivatives markets as well.

Jodi Xu in the FT’s Debtwire noted recently that money provided by ETFs accounted for 41% of the high-yield retail space for the first 19 weeks of 2012, up from a previous 10%. In some weeks they accounted for over 80%. Some bond fund managers chased ETF performance as the fast money ran in and out exposing yet another sector to a potential fall should the financial merry-go-round suddenly stop spinning.

Concerns surfaced back in 2011, especially for banks looking to boost profits, and in particular European banks. Those risks have turned into a present-day problem. The FT reported on May 23rd: “More than three-quarters of the synthetic exchange traded funds listed in Europe are at risk of closure after failing to attract sufficient inflows in their first three years since launching, according to Rick Genoni, global head of ETFs for Vanguard. . . [Genoni] noted that half of all ETFs, including synthetic and non-synthetic, launched in Europe in the last five years were in the “danger zone”.

At some point maybe banks will get back to lending real money to actual companies that sustain and create much needed jobs, all for a reasonable profit. That doesn’t take financial wizardry, just common sense.

 
Photo credit: Brian P. Klein, 2012 – Industry lost along the rails, east coast U.S.