Monday, June 14, 2004

Hard Truth of China's Soft Landing?

Hard truth of China's soft landing
By John Dizard

And this from Stephen Roach as a kind of counterpoint.

There's been a debate about whether China will be successful in gradually slowing its economy down to a "soft landing". Over the past couple of weeks a consensus opinion has emerged that a combination of administrative measures and market forces is working effectively to achieve that happy ending.

Consensus opinion is dead wrong.

Not only will there not be a soft landing in the future, but a hard landing is already here. This has been an investment boom such as the world hasn't had since the early years of the forced-march Soviet industrialisation, reaching near half of gross domestic product. The figures just out show a decline in the year-over-year increases since February but, more significantly, a very rapid decline in the month-to-month numbers.

"There was a 20 per cent fall in investment from March to April," says one economist on good terms with the Chinese authorities, and the numbers from April to May seem to have fallen even faster. Investment numbers are lumpy on a month-to-month basis, but we'veseen enough data from the beginning of the year to know that production has peaked. Certainly by December, the year-over-year numbers will be negative.

"China also had a trade surplus in May, another indicator that investment is falling off. This is really going to hit Japan, which has been helped by exports to China, but the Koreans and the Thais will be even harder hit."

This supports the idea I floated last week: China will be seeking to devalue the renminbi by next year. US politics are in the way here. Mickey Kantor, one of the Kerry campaign's trade advisers, has been saying that China's fixed exchange rate has amounted to an illegal export subsidy. The subsidy is supposed to come from an excessively low value of the renminbi against the dollar, artificially lowering Chinese export prices. In effect, Mr Kantor is demanding that the Chinese float their currency against the dollar. He is assuming the renminbi would rise against the dollar, and thus lower the Chinese trade surplus with the US.

What if the Chinese were to say: "We surrender, Mr Kantor. We'll float the renminbi against the dollar. You win."? With an investment collapse under way, and already-promised liberalisation of Chinese institutions' ability to invest abroad, a freely floating renminbi could easily plunge against the dollar. Since the Chinese government is apparently planning to cut public sector investment, the economy would need to offset the investment and state sector weakness with more exports. It is not clear where those exports would go.

But if Mickey Kantor's crowd gets a floating renminbi soon, they might find an even more receptive market here.

It takes a while to sort through Alan Greenspan's speeches and testimony to find out what wasn't said, and his statements in the week are full of half-revealed truths. For example, he told us that "an unwinding of the carry trade is notably under way".

In other words, people in the market have put on short positions in the equivalents of the 10-year Treasury bond, so the potential systemic risk from a rise in rates isn't there any more.

Wait a moment. Risk does not just disappear when market operators hedge their positions. Who's being saved here, and who's being fitted with a concrete parachute?

Apparently Chairman Greenspan was talking about the hedging programs of the 22 primary dealers such as Goldman Sachs, Morgan Stanley, Merrill Lynch and the dealing arms of Citigroup and JPMorgan Chase, Banc of America Securities and so on. Those firms are the instruments through which the Fed executes its monetary policy. In the collective mind of the Fed, they feel pain more acutely than the rest of us, and need succor and support if they are to perform their natural role.

So who are the chumps? Who's been buying the bonds, the duration that the primary dealers haven't been buying?

Let's see . . . who would be the dumbest, most self-destructive people at the card table? How about the foreign central banks?

According to Gerald Lucas, a bond strategist at BoA Securities: "A number of the foreign central banks that intervened to support the dollar in the months past have been recycling their bank deposits into Treasury bonds. If you look at the auction for the five year Treasury on June 9, indirect bidders were a record 56.6 per cent. A lot of those will be foreign central banks." Some of these banks have been pushing out the maturities of their bonds purchases from the traditional two-to-five-year range to ten years.

Of course, there are bond buyers other than foreign central banks, such as pension funds, life insurance companies, and other so-called "real money buyers". "Real money" means you didn't borrow to buy the paper. Mr Greenspan's warning was a way of saying that the boat has sailed without them, at least for the rest of the tightening cycle.

But the profit and loss accounts of US Treasury investors are going to look pretty good soon by comparison with those of the owners of the Japan government bonds. Of that, more later. ...Link

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