3 May 2009

China Shows the World How to Get Through a Crisis


Call me mad but this crisis is good for China. It is also good for China’s role and responsibilities in the world.

Yesterday, we upgraded our gross domestic product forecasts for China for 2009 and 2010; we are now looking for 8.3 and 10.9 per cent, respectively, up from 6 and 9 per cent.

Why the optimism? It was clear that the massive rise in exports, the mainstay of the China growth model until 2008, was not sustainable. At one stage in late 2007, Chinese exports to the US alone were about 12 per cent of total GDP. This meant that exports would suffer badly in the event of something going wrong with demand in the US, and the risk of a protectionist backlash.

This led some of us to expect an end to the fixed Rmb8.28 exchange rate to the dollar and a gradual shift to a more flexible, stronger exchange rate a few years ago.

Fast-forward to the crisis. When this intensified post-Lehman, global trade suffered enormously and quickly, and it was clear that Chinese growth would suffer. It was also reasonably clear that, just as they did in response to the Asian crisis in 1997, Chinese policymakers would react swiftly and shift gears. That they have done.

Three policy initiatives stand out, and the results are starting to bear fruit, hence our upgraded forecasts.

First, in November the authorities announced massive fiscal expansion, centred on fresh infrastructure spending. While my industry has quibbled about its true size ever since, this misses the point. The statement of intent was clear; interestingly, the stock market noticed and has rallied since.

Second, and ultimately perhaps the most important development in the world economy, the government announced plans to develop a full medical insurance policy for the still vast rural community, the beginnings of which it plans to have fully implemented for 90 per cent of the rural community by 2011. This could result in an end to the excessively high Chinese savings rate and allow much stronger consumption.

Third, and critical to our forecast upgrade, the authorities, led by the People’s Bank of China, embarked on a timely reversal of tightening financial conditions of the previous two years. According to our Chinese financial conditions index, conditions have eased a huge 520 basis points since last October.

These three measures have set the scene for an acceleration of Chinese domestic demand for the rest of 2009 and 2010, just the right recipe for China and, critically, the world.

The next stage of China’s development has started and is likely to go on for years. It was partly in anticipation of this that we highlighted owning China "A" shares as one of our most favoured trades for 2009. As they have risen 50 per cent since the November stimulus announcement, the entry point is now less attractive but, as evidence of rising demand accumulates, many investors are rightly going to be attracted back to China.

The "C" in the Bric economies (Brazil, Russia, India, China) has always been the most important of the four and the events of the past five months continue to justify our excitement for the longer term.

Amusingly, in the past year many people have suggested that the Brics story is over. Nonsense - it is still in its infancy. Indeed, the updated longer-term projections we published last summer, suggesting that China could overtake the US by 2027 and that the Brics collectively could be as big as the G7 by 2027, still look decent bets to me.

At some stage in the coming months, once it becomes clear that Chinese GDP growth is safely back above 8 per cent, policymakers will allow for some tightening of financial conditions again, possibly led by the exchange rate.

In the next two years, China is very likely to overtake Japan to become the second-largest economy in the world. Some say that China might get old before it gets rich, but it is getting bigger and richer, that is for sure. One or two of its ageing G20 partners may wish to take a closer look at Chinese economic policy to see how it’s done.


The Indian stock market has been doing well after the Satyam scandal. Now, the elections are underway and results will be made public May 16th. Some investors will wait until after the national elections to make sure the probable coalition government will be effective. If the parties on the left, the Marxists, communists, etc. are included, you could have an ineffectual government which could result in a market setback.


The U.S. Federal Reserve has tripled the size of its balance sheet in recent months. Deficits in the U.S., Japan, and Europe are at record percentages of GDP. This, plus the big money supply expansion in many parts of the world, both argue strongly for a resurgence of inflation, most probably by the second half of 2010.

Stock markets are discounting mechanisms. One need only look at the current stock market rally worldwide, while world economies continue to weaken, to see that they are discounting a recovery. Is the recovery one year away? Two years? The market thinks it is more likely 12 to 18 months. In any case, the eventual resurgence of inflation is good for commodities, especially gold, agriculture, and oil. We believe that the recovery will include a slow growing, but stable economy for a few years in the developed world, and steady growth in China, India, and a few other countries.


Who holds the gold? Recently announced numbers show that China has upped their gold holdings to over 1,000 tons, making them #5, after the U.S., Germany, France, and Italy. India is #10. China’s recent announcement that they had increased their gold holdings indicates once again China’s efforts to strategically position themselves to be a leader in the community of nations. Remember the old cliché about the golden rule? He who holds the gold makes the rules.


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