A Contrarian View on China's Currency Move

The latest push by Beijing to accelerate the opening of China's capital account to foreign investment is undoubtedly a good thing. A good thing for the world as it helps reballance the global economy. However it is being hailed as a cure-all for China's slowing economy in China Currency Move Nails Hard Landing Risk Coffin. Not meaning to pick on Paul Markowski here (although as long-term adviser to Beijing he is hardly impartial) - this is the general view across the financial media at the moment.

We believe it is also incorrect. Beijing is clearly aware of the undeserved benefits that acrue to the

There May be Trouble in Beijing

Ever since the neo-Maoist princling Bo Xilai was dismissed from the top Communist Party post in Chongqing, rumours have been circulating of a military coup in Beijing. Asia Times writes

Rumor mills on China's active blogosphere were rife with claims that a military coup had occurred in Beijing, with gunfire, tanks and soldiers on the streets.

They do appear far fetched, and could be easily dismissed as such, if it weren't for the official denial and draconian measures against websites that may have facilitated their spread. In China arrests over

Beijing Cannot Deflate China's Real Estate Bubble

According to comments made at a State Council meeting and published by Reuters, Chinese Premier Wen Jiabao

wants to see a "reasonable pull-back" of housing prices.

The government will clearly keep tightening credit to developers and restricting purchases of multiple homes for speculative purposes. The intentions are certainly admirable - everyone agrees that affordable housing is a must for social stability. However once the bubble has inflated, it often can only either keep inflating further or simply burst.

Can One Trust China's Economic Statistics?

The Dec reading of the Chinese official Purchasing Managers Index came in better than expected at 50.5. This would indicate a small expansion in manufacturing activity. If it were free of official manipulation, that is. And therein lies the issue with China's economic statistics - it is not clear if the numbers can be trusted.

Anecdotal evidence has been pointing to shrinking margins and difficulty in obtaining financing for the majority of Chinese small and medium manufacturers. Guangdong province is home to a large percentage of Chinese manufacturing and has in the past been dubbed "the factory of the world". However a survey by the

Commodities Super Cycle Reversing Course

According to this Reuters article,

Last year had the lowest commodity inflows of the past nine years, with fresh investments dropping almost 78 percent compared with 2010, Barclays Capital said on Thursday.

Investors in precious metals and energy had a very volatile experience in 2011 and many are wondering if it really is the sure bet that they expected. For example Gold has had a big rollercoaster of a ride and Silver has been even more volatile (see a previous WhatIf post Gold Appears to have Lost its Shine for more details on the metals).

With Beijing trying to rebalance China's economy away from investment and towards consumption, the huge bursts of residential construction and capital investment may be behind us. As we have seen before, construction is unlikely to be picking up anytime soon and if China is headed for a slowdown, demand for most industrial commodities will drop considerably. Barclay's prediction of volumes and prices picking up notwithstanding, it appears that the market has reached a turning point in its 10-year cycle.

AUD a New Safe Heaven? Bad Joke

As WhatIf has mentioned earlier, the fundamentals are not looking good for Australia. All the non-resource sectors appear to be stagnating, to a large extent hurt by the strong currency. At the same time material exports, while very strong at the moment, are mostly going to China. And China is slowing down.

There has been some talk in the market / media of the AUD becoming a new safe heaven as one of the very few remaining AAA economies. It's a nice story but clearly not true - a minor hiccup in equities still sends Aud/Usd tumbling. As it should, seeing as Australia's economy is to a large extent just a leveraged, liquid bet on China.

Chinese Real Estate in Broad Decline

We have already seen anecdotal evidence of sharp price cuts by property developers eager to move inventory of unsold homes (China's Housing Crash is Gathering Momentum) or sharp drops in the most speculative luxury vacation home market (Property Prices in "China's Hawaii" Down Almost 30%). The market reversal is now spreading with Dec marking the third month in a row of negative average growth of home prices in all of China. Moreover, according to Reuters, prices dropped in 52 out of 70 cities. The situation is far from desperate but can get worse very fast with the government continuing efforts to reduce property speculation, developers losing access to funding and new home sales slowing to a crawl. The real trouble will probably start when prices in all cities start dropping at the same time.

China's Housing Crash is Gathering Momentum

While it is nothing new, watching this in real time is really quite instructive. Vanke is the largest mainland property developer and according to Caixin Online:

In the fourth quarter, Vanke's sales in 14 major cities dropped 45 percent by area from a year earlier, while home transactions in smaller cities also slowed down significantly 

The drop in sales of 45% is staggering! At the same time properties are exiting the construction pipeline, increasing inventories and necessitating an aggressive sales approach (read "fire sale"). Developers are already starting to offer deep discounts on new condos. Realtors are also getting desperate - one WhatIf source in Shanghai said agents would position themselves at crossroads and after waiting for the light to turn red, try to pass out leaflets to the drivers of expensive cars.

Is China Calling the End of the Gold Bubble?

PBOC has announced that all Gold exchanges except for the 2 main ones in Shanghai are to discontinue operations (see the English language US edition of China Daily). It thus forcibly consolidates the market within a few large players, that are easier to monitor and control by the authorities. So far nothing new. The Chinese government has always operated this way in regards to any politically sensitive areas of the economy such as banking, insurance and most recently rare earths exports.

The timing, however, is quite interesting. Gold has been going up and investor interest in it has been building for the past 10+ years. However the regulation tightening only comes now that the market has experienced a few major hiccups (see previous WhatIf posts on Gold below, also FT article on recent sharp decreases in Gold ETF holdings). Beijing probably fears a public backlash should Gold continue to collapse, causing large losses to naive individual investors. The memory of the vocal protests before the building of the Stock Exchange after the Shanghai Composite dropped from its lofty heights in the end of 2007 must still be fresh in their minds.

Can China Micromanage the Convertibility of its Currency?

China has recently signed a series of bilateral agreements for limited direct settlement of FX transactions. First with Russia, Indonesia, Australia and more recently with Thailand and now Japan (see BBC article). All of the agreements are aimed at facilitating trade settlement without the need of using US dollars. Also they all seem to be restrictive enough to allow for careful monitoring and control by Beijing. As an example, the agreement with Thailand only allows CNY/THB settlement in the province of Yunnan (bordering Thailand) by the local branches of 4 designated banks. This approach to gradual convertibility is similar to the Special Economic Zone model that China used in the past to introduce capitalism to the country in a limited way. Despite all the media hype, the yuan is very far from challenging the dollar as a global reserve currency. But gradually allowing convertibility of the current account (currency flows based on trade in goods and services) may just work out.

Property Prices in "China's Hawaii" Down Almost 30%

What is the first thing you do when you have an extra million or ten? If you are like most people you go and buy a luxury vacation home. But that would also be the first to go when you realise your business won't be going to the moon quite as fast as originally expected. The second phase of that is currently going on in China's "tropical paradise" of Hainan where prices are down 28% year-on-year (see Bloomberg article).
Vacation property is the first to go down when the market starts turning. Consider the fate of Miami in the US, Greece and Spain in Europe. Usually the rest tends to follow, especially in a market that has gone much too high by any fundamental measure. Official statistics out a few days ago showed that property prices in most Chinese cities are now also dropping. Beware the super-bubble.

Has the Chinese Yuan Topped Out?

Ever since the initial 8.1 peg to the USD was scrapped in 2005, the Chinese yuan (a.k.a. RMB) has only gone up. Investors have been piling up into dim-sum bonds and US politicians keep ratcheting up the pressure on Beijing to revalue its currency. Now if the RMB is so undervalued, why did hte PBOC need to intervene to support it on Friday? (see WSJ article). In fact, it had already hit the lower limit of its officially stipulated trading band for a few days in a row.

If capital controls are lifted, the country's large current account surpluses should drive the value of the yuan higher until the resulting drop off in exports (as they get pricier) and pick-up in imports (as they get cheaper) balances out. This is according to popular wisdom and Economics 101, but completely misses the capital account part of the equation. And that one is tricky.

If investors could freely move funds across the border, would money flood into the Red economy driving the RMB higher? Or would the enormous pool of currently captive domestic savings instantly rush out to seek returns higher than the deposit rates of state-owned banks? The market is telling us the latter is more likely.

China Flexes its Muscle Again

China has announced that it will levy anti-dumping duties on US-manufactured car imports (see FT link). The taxes will mostly affect luxury vehicles and as such will only have a limited economic impact. The impact is mostly political and this is the latest move in China's unwritten policy of asserting its newly acquired clout on the global political and economic stage. The emerging "superpower" has been busy escalating territorial disputes with just about all of its neighbors which pushed the US last month to increase its military commitment to the region by stationing 2500 marines in Australia (see NY Times link). This stream of international provocations also probably serves to fuel the patriotic fire at home in order to deflect attention from the increasing (and mostly unreported) instances of riots and violent protests. Keeping its grip on power will be the biggest challenge for the Communist Party into the transition of leadership in 2012.

Corruption in China

The final verdict is out on the most infamous of the Chinese "fraudcaps", Sino-Forest Corporation. The company has officially defaulted on an interest payment of as little as $10mm (see FT article). The widespread corruption in China creates a fertile ground for fraudulent investment schemes. Transparency International  in its 2011 report ranks China at #78 in the world (the higher the number the more corruption). The same report ranks Canada as #10 and the US at #24 (interestingly Hong Kong is ranked #12).