Tuesday, September 27, 2011

Cash Crunch in China Picks Up Momentum; Chinese Economy "Teetering On the Edge"



Yesterday’s Mish Shedlock title for his blog!  Basically, the Chinese government has been putting the screws to the economy in order to slow down the, out of control, housing market before something bad becomes terrible.  There is something like 65 million empty apartments in China – constructed but with no electricity provided – basically unoccupied.

In China, as in most of Asia, people like new things; this is also true for housing – go figure!  Still it is what it is, so if you buy an apartment as an investment you want to keep it “pristine” and therefore unoccupied form, so that you get full value when you sell it.  Think of an apartment as a car, a soon as it leaves the show room it looses value.

So the Chinese government has been aware for some time that excessive investment in real estate has taken place, for two years now the Chinese government has been trying to slow the housing market, and its latest tactic is to starve the market of credit – raising capital requirements and making life hard for the informal financial market.  The impact is clear to see, as cash is flow back to china and the differential between off shore Yuan and onshore one has narrowed dramatically.   

About 75% of China’s economy is investments; infrastructure (roads & Bridge) manufacturing (steel, concrete etc) and housing (discussed above).  Now the steel industry and the concrete industry are geared to local asset expansion, bridge and roads require concrete and steel as do housing, which also requires wood, bricks and copper and other material.

NOTE: here comes the Canadian connection.

Canada like Australia is very dependent on trade for its GDP, as an example about 1/3 of Canada’s GDP relates to exports – and a great percentage of this is raw material (Oil, Iron Ore, Zinc) and commodities (Wheat, soya etc).  America our immediate neighbour, and largest trading partner, has a much lower dependence on trade (around 10% of GDP), so whenever an America politician says that trade will save the U.S., the only answer is: In what universe?  Back to Canada, China is not only Canada’s third largest trading partner (after America and the U.K.) it is concentrated in the “things that are heavy” segment.  Yes Canada has exported some mass transit products and aircraft but overall the Canada to China trade is one of raw materials. 

Canada is a second derivative country, we are not the market we are not the maker of the product, we are the provider of the inputs for the countries that make things – it may seem a lowly position, but it has served Canada well, and in fact Canada cannot compete with the Chinese (or Vietnamese) for labour costs.

But is also means that when things go bad in America (and they seem to be really bad), the U.K. (really same boat as America, maybe a little further along – but a long way to go) we have to rely on the growing demand for raw material by China to feed our economy.  Now the signs are that China is getting close to the precipice:  its two core consumers (Europe and America) are in trouble – Japan its third largest market (really an intermediary to sell to America and Europe) is facing the same pressures.  Moreover, the Chinese government is becoming concerned about its debt burden, for while the country’s borrowings are reasonable, because China is a command economy it also effectively guarantee the debt burden of local governments, and state owned enterprises.  Bottom line whereas China’s sovereign debt is low, aggregating the debts of SOE and local governments brings the number much, much higher!  The Chinese authorities in 2008 injected about $700 billion into their economy – to avoid a recession, an amount equal to what America invested, but a smaller economy and most of the funds were used for building things (the bulk of funds were transferred to state and local government to keep things going… far less stimulus).  Chinese are unlikely to have the same appetite, moreover, with the high inflation (due in large part to an undervalued Yuan – to support unprofitable exports) the Chinese authorities’ hands are tied.

That spells trouble for Canada…

Impact will be two fold, we can expect a weakness in the price of raw material (already king copper has taken a hit), other like Zinc (stainless steel) and oil are sure to follow.  The impact on the CAD is certain to be important, especially since the weak dollar policy seems to have been reversed.  My guess is that the CAD could fall to the 92/93 range depending on the depth of the Chinese slow down.  This could be a difficult ride for Canada – it may be that the BoC’s 1.9% GDP growth forecast in 2012 is optimistic, personally I think that the 2.2% growth forecast in 2011 is very optimistic, considering that the first half generated growth of only 0.7% (Q1 +1% Q2 -0.2%).

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