Daily Archives: October 13, 2011

Shorting China?

Written by Paul Adkins

This morning I attended a “breakfast briefing” with the new Australian Ambassador, Ms Frances Adamson. She gave the usual speech, full of enthusiasm but straight from the official songbook. There was one question however, which caused her to give an impromptu answer. Ms Adamson has a PhD in Economics, and a career diplomat, so her answer should not be quickly dismissed.

The question was about China’s re-casting of its economy towards a more consumption-driven model, and how long it would take. She made the following points:

* China’s 12th 5-year plan is geared towards the objective of moving to a consumption model.
* There is no doubt that China’s economy will eventually be based on consumption rather than investment, though it is a matter of conjecture as to how long this will take.
* Plenty of people have bet against China over the last several years, and so far none of them have been right. She would not bet against China now either.

These comments led me to thinking about some of the articles and opinion pieces that have been in the press lately. Several leading economists have been criticising China’s housing bubble, non-performing loans and other blemishes in the economic fabric. Others have been considering China’s alleged inability to perform another stimulus package like it did in November 2008.

While it’s true that China’s economy is far from perfect, I believe that the real drivers remain unchanged. China is continuing its program of urbanisation, and this momentum will yield a number of significant results.

First, to house the 120 million or so who will transition to cities over the next 10 to 15 years, China must maintain a steady growth in new cities. That means steel, glass, concrete and aluminium. While those industries will be controlled lest they get out of hand, there is an ongoing need for growth in these industries. That means investment. Urbanisation is not something you can start and stop like a light switch. This is a major ongoing program, embedded deep within the 50 year plan that Deng Ziaoping laid out.

Second, as those poor rural folk move into the cities, and begin to improve their income, Chinese people will have an increasing level of disposable income. They will start to buy goods to go with their new homes and lifestyles. Domestic consumption will grow, but to avoid rocketing prices as demand outstrips supply, the Government will encourage further investment in factories and secondary industry, to produce the goods that consumers want.

The bottom line is, China has plenty of demand, most of it latent at this stage. China does not need another investment-driven stimulus package. It needs only to loosen the reins to unleash that demand.

The question is, when. The balance of trade figures that came out today indicate that exports are continuing to shrink, as the Eurozone and US grapple with their own problems. The move to buy shares in China’s banks may well be the first “shoe”. Although most economists have rightly pointed out that this is a cynical move from a market point of view, perhaps it wasn’t meant for the market at all. Perhaps it was the first step in recapitalizing banks ahead of a slight easing of the tight monetary policy. Banks are now effectively better able to fund new loans, thanks to the share buyback.

I discuss this with a friend of mine, who thought that the start of the fourth quarter was not the right time to start easing monetary policy. I am not so sure. Taking the latest balance of trade figures, the relatively short time left for Wen Jiabao and the present State Council (they have 12 months left), the ability to influence 2011 GDP’s figure and the lack of another suitable time (Q1 2012 is beset with Chinese New Year, leaving any significant change in the economy delayed until Q2), all indicate to me that perhaps an easing is coming sooner rather than later.

We shall see. But I would not be shorting China. There may be dips and bumps along the road, but China still has a long way to go.