The Shanghai and Shenzhen stock markets are still hogging the spotlight. Although down 18.0% from its recent peak exactly one month ago, the past three days have been good for Chinese stock market investors. After rising 0.60% on Tuesday and 1.17% on Wednesday, the SSE composite was up a very smart 4.79% today.
So what happened? Better-than-expected earnings from Chinese corporations? A surge in US household income and a decline in US unemployment boosting the prospects for China’s tradable goods sector? A huge new loan number for the month of August?
Actually, none of the above. In fact the US numbers look especially bleak for China. In spite of some seemingly good news on the macroeconomic side, unemployment in the US is still rising, and even that masks the depth of the problem. Many Americans who have lost jobs have since then found new jobs, but at lower pay, so that although they don’t show up adversely in the unemployment data, they nonetheless represent lower income to workers as certainly as rising unemployment does, and this will have an impact on future private consumption.
Societe Generale’s ever bearish Albert Edwards had an excellent piece on the subject on August 6, in which he argues that:
US nominal household incomes are now contracting at an unprecedented rate. The largest component of household income is wages and salaries which had been declining some 1% yoy. But after revisions the statisticians now admit to an unprecedented 4.8% decline! Total pre-tax household income is now recorded as falling 3.4% yoy in June.
If US household income is declining so sharply, we can’t really expect a sharp pick-up in imports, even ignoring the fact that households are also in the process of deleveraging, and so cutting back even more sharply on consumption that their incomes might indicate. But in spite of still-bad news in both the external or internal environments, the markets are nonetheless in a much better mood than they were just a few days ago. Why? The People’s Daily explains:
Chinese equities climbed Wednesday after the country’s securities regulator said it would take measures to promote the steady and healthy development of the market.
Or, if you prefer Bloomberg’s slightly more forthright explanation:
China’s stocks rose the most in two weeks on speculation regulators will adopt measures to boost the nation’s equities following declines in the past month.
The main cause of the surge seems to be a statement made Liu Xinhua, vice chairman of the China Securities Regulatory Commission, at a forum in Beijing yesterday which was proclaimed on the front pages today of China’s two biggest financial newspapers, the China Securities Journal and the Shanghai Securities News. Mr. Liu promised that regulators will promote a “stable and healthy” market. This has been interpreted to mean that the authorities will not let the market continue falling, and will introduce measures to force it up.
Bloomberg continues, with something that is widely acknowledged but wasn’t covered in the People’s Daily article:
The government may take measures to stabilize the market before the 60th anniversary of the founding of the People’s Republic of China on Oct. 1, the start of a weeklong holiday. “They want everything to be stable and in harmony,” said Francis Lun, general manager of Fulbright Securities Ltd., in an interview with Bloomberg Television today. “They will approve more stock market funds and allow them to buy into the market.”
There is a general sense that no one wants the markets to misbehave before the all-important October 1 celebration of the sixtieth anniversary of the birth of the People’s Republic. Needless to say this begs the question about when exactly should you, as an investor, get out of the market? The day before? But if everyone knows that, then shouldn’t you get out two days before, or maybe three, since everyone has presumably figured that one out too?
In 2006, 2007 and 2008 I wrote often about the dangers of this sort of market signaling. There may be perfectly good reasons to want to manipulate the markets with non-fundamental information, but every time this happens it further undermines the development of a healthy capital market that allocates capital based on economic prospects by undermining the value of fundamental information and reinforcing the value of speculation on government intentions. Still, on such an important anniversary I suppose it was totally unrealistic to think that the authorities would let angry investors spoil the party.
The stock markets may have also taken some heart from a good, although sobering, speech from Premier Wen when he met with World Bank President Robert Zoellick earlier this week. According to an article in Xinhua, Premier Wen said that:
China’s government would continue to pursue proactive fiscal and moderately easy monetary policies. ”We will not change the orientation of our policy,” Wen said.
Wen said China would fully implement and continue to enhance and perfect policy in response to the international financial crisis to achieve the goals of economic and social development.
This was taken by everyone as a pretty clear conformation of what I discussed in last week’s entry – that although there were increasing worries about the cost of the fiscal stimulus package and the lack of an “exit strategy,” in the end the State Council and the policy leadership were still more worried about a sharp slowdown in growth than about the risks of excessive investment:
I wonder, and I know I am not the only one wondering, what Zhongnanhai is thinking as it sees the impact of these rumors of a contraction in the furious rate of credit expansion. For one thing it seems that there are only two positions on the switch – “surge” and “swoon” – and I suspect that very quickly we will see the switch turned back to “surge”. Although there seems to have been a little upward blip in US import numbers, I think this represents more of a temporary bounce from a steep earlier decline, and that the external environment continues to be very poor.
My guess is that if the local stock markets do not soon recover their bounce (and they won’t without government help) and, even worse, if we start to see the awful sentiment seep into the real estate sector, Beijing will once again push forcefully for credit and fiscal expansion. In my opinion there is simply no way that domestic consumption – unless it is primed with government giveaways – can make up the slack quickly enough.
A recent report by CLSA also says that the PBOC apparently believes that one of the causes of the lost decades of Japanese growth was premature tightening in the late 1990s which “killed the momentum of economic recovery when it was only in the budding state,” and so the PBoC has cautioned against doing the same in China. It is better to be too loose than too tight.
Although I think perhaps the right comparison is not with Japan in the later 1990s but rather with Japan in the late 1980s, this “lesson” was reinforced by another, according to the same report:
Beijing seems to agree with Ben Bernanke that “The correct interpretation of the 1920s, then, is not the popular one–that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy – both domestically and, through the workings of the gold standard, abroad. The slowing economy, together with rising interest rates, was in turn a major factor in precipitating the stock market crash.”
Although I think I agree with Bernanke, again, I am not sure this is the right lesson for China. The problem is that loose monetary policy is exacerbating the imbalance that China needs to work though, since most of the expansion is being directed at investment in expanding current and future capacity, but this comes at the cost – which was not the case in the US – of constraining the future growth in domestic consumption. Without rapid future consumption growth, as I have argued many times, I just don’t see how China can support rapid GDP growth once the huge fiscal push becomes unsustainable and runs out of steam.
Clearly this concern is still part of the internal debate. Chi Fulin, president of the China (Hainan) Reform and Development Research Institute and a member of the Chinese People’s Political Consultative Conference had an interview which was reported in an article in today’s People’s Daily. In his comments he makes many of the same points I have been worrying about, albeit perhaps in a more politically acceptable way:
Chinese leaders should rethink the country’s reform package amid changing global and domestic situations and take “quicker and radical” steps to move toward a market-oriented economy by 2020, said a senior political advisor. The reform measures should speed up urbanization, break down industry monopolies by the State, deregulate energy, offer equal social welfare for both rural residents and urbanities, and improve the government’s efficiency.
“Our top leaders should take quicker and radical measures in these endeavors within the coming two or three years. By doing so, China can do a better job in post-crisis management as well,” Chi Fulin, president of the China (Hainan) Reform and Development Research Institute told China Daily in an exclusive interview. “Looking at the goal of realizing a market economy by 2020, we cannot afford to lose the time window of the next two or three years in the reform.”
Several times in the interview Chi mentions the “urgency” of the need for reform, which included removing many of the production subsidies, price deregulation of resource products, and reducing the State’s industry monopoly. My interpretation of his comments is that he is, as politely as possible, warning that the government still hasn’t taken the necessary steps to restructure the economy. He concludes “Whether consumption can become a leading engine of China’s economy depends on how successful the reform is.”
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