My Blog

August 28, 2008

I was in Shanghai for the past two days and so wasn’t able to write anything on my blog, although it doesn’t seem like a whole lot has happened recently to add to our understanding of the Chinese economy.  The stock market continues to behave poorly, with the SSE Composite dropping 2.6% on Tuesday and 0.3% Wednesday before reversing Wednesday’s losses to close up 0.3% today at 2350. 

The weak rally was driven by higher-than-expected profits among consumer-related companies, although I wonder how much of that increase was caused by a one-off jump in Olympic-related spending.  I guess it is worth noting that once again we are close to the 2300 level, although during my meetings in Shanghai some of the fund managers spoke of 2250 as being the level at which we were expected to see government support.  Who knows?  At any rate they weren’t a particularly enthusiastic bunch.

I am not allowed to be too specific about details, but one impression I got from these meetings is that new equity funds launched in recent months have been supported by some pretty aggressive selling, with high-fee incentives paid to the commercial banks and brokers who are responsible for raising the money.  This is all very impressionistic, and I don’t have concrete details, but I wonder if some of the retail investors who have put money into the funds are fully aware of the risks they are taking.  When salesmen are put under significant pressure to sell new funds to retail investors, and are rewarded with high fees when they do, there is always the risk of salesmen misstating the risks and rewards associated with the fund.

This could be a problem if markets continue to decline, and clearly the possibility of further declines weighs heavily on the administration.  Today in the China Daily there was yet another article (these have become regular appearances in the Chinese press) arguing that a post-Olympic slowdown is unlikely and quoting a host of experts, including inevitably, Lin Yifu, the chief economist and vice president of the World Bank, who believe that there are few risks of a post-Olympic recession.  Still, in the same edition the newspaper had another article called “Economy to face challenges in second half,” in which it warned about the increasing uncertainty:

China's economy has maintained steady and rapid growth in the first half but faces increasing uncertainty for the rest of the year, a senior government official said Wednesday.  “Negative impact on the economy will continue,” said Zhu Zhixin, vice-minister of the National Development and Reform Commission (NDRC), China's top economic planner, in a press conference.

In support of Zhu’s concerns, there was an interesting if alarming Op-Ed article in today’s Financial Times by Joe Quinlan, chief market strategist at Bank of America, who argues that global private consumption, which jumped 11% in 2007 and rose by an average of nearly 8.5% a year from 2001 to 2007, is likely to rise by only 2-4% this year.  He warns (and I agree) that the global de-coupling thesis doesn’t take into account the huge rise in developed-world consumption as a share of total consumption, which itself explains the growth in developing countries exports as a share of total exports.  

Add to that further problems in the US banking sector – an article in today’s South China Morning Post says that the FDIC’s list of problem banks increased by 30% in the second quarter to the highest total in five years – and China clearly needs to worry about a downturn in global conditions.  If world consumption slows, this is likely to be a real problem for countries like China.  

The China Daily article goes on to report on Zhu Zhixin’s press conference:

China's grain production amounted to 120.4 million tons, a record high. The authorities also managed to restore pork and vegetable production, despite natural disasters such as snowstorms and earthquake hitting the economy hard, Zhu said.

However, analysts have said that the outlook for the sector is uncertain with extreme weather posing a challenge.  Rising prices of fuel and fertilizer have also eaten into the profits of farmers, which may serve to discourage increases in production in the second half, Zhu said. He added that the government will continue to support the agriculture sector.

That sounds ominous.  The one success in the fight against inflation has been that food prices, after a dizzying rise late last year and early this year, have receded somewhat.  For those of us who believe the fight against inflation has been all but won, this suggests that with the main driver of inflation in deflationary mode, there is little risk of another upsurge.  

Those who believe the fight against inflation has only just started will argue that a relaxation of food prices is not unexpected given the huge and clearly distorted run-up earlier in the year.  The question is whether inflation will spread to the non-food sector or whether there will be further interruptions in food supply that create another round of food-led inflation.  My understanding is that there is little room for any disruption in food production and there are significant shortages in energy – which both suggest a bigger probability of an upside surprise than of a downside surprise.

Xinhua, by the way, had a very different take on Zhu’s press conference.  They stressed his continued worries about inflation.  In today’s “Chinese official: curbing inflation a priority after Games” Xinhua says:

The Chinese government will stick to an economic policy that focuses on curbing inflation for the rest of the year, a senior official on Wednesday told China's top legislature, as slowing output and rising prices loom over the post-Games economy.  Economic planners would exert themselves to increase supplies of necessities, closely track key prices and make price controls more effective, National Development and Reform Commission deputy chief Zhu Zhixin told the fourth session of the Standing Committee of the 11th National People's Congress.

“A lot of factors can drive prices up,” said Zhu. “There is a strong demand for primary products, with prices hovering high on international markets, while more expensive land and labor at home will add to costs.”

In spite of these inflation warnings few analyst expect that there will be further monetary or credit tightening – in fact there are a lot of rumors going around that the PBoC’s next move, coming soon, will be a reduction in minimum reserve requirements.  Since the lending caps have been the main constraint on loan growth (and they are being relaxed), not the minimum reserve requirement, I am not sure I believe the rumor, but even if it is true it is not likely to have a big impact.

On a separate note a lot of local newspapers are reporting a release yesterday by the Auditor-General Liu Jiayi.  According to an article in today’s People’s Daily:

Central government departments and their subordinate units misused or embezzled about 4.52 billion yuan ($661.09 million) last year, for which 14 officials have been detained, the country's top auditor said yesterday.

…More than 41.7 billion yuan ($6.09 billion) of central funds were mismanaged, too, the National Audit Office (NAO) said.

If the NAO is truly able to ferret out fraud, graft and misuse of funds, this is clearly a good thing for China.  One thing that did catch my eye, however, was that, according to an article in today’s Financial Times, “The audit also found that China’s four state-owned asset management firms – Huarong, Cinda, Great Wall and Orient – could face difficulties because they had not earned enough from selling non-performing assets to pay the interest on their debt.”

The asset management companies (AMCs) were created to help resolve the NPLs on the balance sheets of the big banks.  For the most part they purchased NPLs at either 100% of face or 50% of face, and “paid” for these with their own bonds.  Since as far as I can remember the collection rate on these NPLs has not been much higher than 20%, it is clear that except for the MoF guarantee these AMC’s would be bankrupt, and because of the MoF guarantee the amount by which they are insolvent should be included as part of MoF liabilities (they usually are not included in most analysts’ calculations of total government debt).

What is interesting to me is that not only are the AMCs unlikely ever to make their principle payments, but they are also having difficulty making interest payments.  I wonder if any of the readers more expert than me on the subject (hint: are you reading this Jack Rodman?) might comment on this.  I would be interested in hearing how healthy the AMCs are and whether there is a more accurate expected collection rate than the roughly 20% I remember having read a year or so ago.

Comments (11) for "Post-Olympic slowdown and AM...

The principle topics of this great blog are Hot Money, GDP Growth, Inflation, Real Estate Price Fluctuations, and many more which are directly related to the general China economy. And this is why over 5000 tune in, daily, according to Bloomberg. Also, on this blog, for example, this past Feb 25th, Mr. Pettis has written very intelligently regarding, “When will China overtake the US economically?”. And, his payback seemed to be a great deal of undeserved negative invective which he needed to immediately remove from the comments section of his blog. But, while intelligently blogging about Hot Money, GDP Growth, and all, still MAYBE there remains the question: Is is JUST possible that one should also be discussing the other factors which so integrally influence these economic outcomes, in order to discuss these economic outcomes? For example, if one were to try to discover the structure of DNA, then one could just rely on Biology and Chemistry. WHY would one even want to invite a physicist whose focus was on X-ray crystallography? Well, the answer is, that it just might get to the truth of the matter. Which it did. The same way goes for this blog, perhaps. One can get overly focused on the easy numbers, and then just manipulate them to kingdom come, but still not arrive at any praise worthy result. Even no predictive potential for what might happen both in the near future, or in the mid future. This is why it might seem reasonable to do a great more research, and enter into the blog, much more diverse information, which is integrally involved, and has a direct and major impact on things such as GDP growth, and the state of the China economy. Not to do this, might have a very negative impact on this blog, read as a historical document, from next year, or even next month. The extra factors which have not been included on this blog, which WILL have a major influence on GDP growth, and the state of the China economy, are, to name a few, water issues, increased outbreaks of AIDS attacking the workforce, lower crop yields due to acid rain and the destruction of farm land, including desertification, the new test of the huge mega-cities which are now being built all around China, ever fluid changes in a central and also distributed government which is doing its best to keep itself astride of a 1.3 billion pound Bucking Bronco. It is one thing to keep blogging, day after day, about the same old numbers. The same old things? Not that this is not a good thing to do. However, COULD IT BE, that what most readers want is a much more insightful look at what is really happening, from a GDP Growth/China Economy point of view? And that the readers want to know how all these major drivers, and limiting factors, will directly influence this growth, TODAY, and in the near future? Otherwise, what is the real point? Just a very simple example: recently Dr. James E. Hansen has sent a very simple and easily understood letter to Prime Minister Yasuo Fukuda. Here is the link to this important letter for those who have not yet read it: http://www.columbia.edu/~jeh1/mailings/20080703_DearPrimeMinisterFukuda.pdf It would be very surprising if most of the people on this blog have not yet read this letter, or at least followed the research of James Hansen during the past 20+ years. But, if no one has read it, then, how could one not read it NOW? WHY is this important? The reason is that this research directly relates to the great bread baskets of China, the water that feeds the wheat growing areas and the grain growing areas. Nothing could be more important than this, when one wants to know about GDP, and economic growth? Let us just hope that this blog will continue to improve. The writer of this blog is very smart. Logical. And really is a true wordsmith. What is needed is some more input from the comments section of this blog to steer readers to the important factors and the drivers that will truly influence the China economy, and help to better evaluate the GDP growth in the near future, as well as other economic data points. By Samuel - 8/27/2008 9:52 PM

AMCs were out of government debts becasue they were written down already. When China restructured big banks and transferred the NPL to AMCs, it actually was a government bailout and NPL was paid by principle as part of government debts. 1400 billion RMB of NPL were transferred to AMCs, 68.61% of NPL had been disposed in 1st quarter 2006. That is the latest public figure I could find online. Cash recovery rate was 20.84% on average. From what I knew in NPL recoveryin China state owned enterprise, the most valuable part would be the land. This should help the recovery in the real estate booming time, but hurt right now. Also those AMCs have strong incentives to postpone the recovery process and transfer some good assets to their other invested entities. I have no doubt that the roughly 30% of NPL left would have a lower recovery rate. By fatbrick - 8/28/2008 12:23 AM

fatbrick: Cash recovery rate was 20.84% on average. From what I knew in NPL recovery in China state owned enterprise, the most valuable part would be the land A 20% cash recovery rate on the AMC assets is quite good and higher than what most people had been expecting. Everyone I know had been expecting that the AMC's would be bailed out by the government, and the question would be how much would then be bailed out. Also it is fair to mark AMC liabilities as government liabilities, however you need to be careful not to double count. If you mark AMC liabilities as liabilities of the Chinese government, then you need to make sure that you subtract those liabilities from the banking system. By Twofish - 8/28/2008 1:15 AM

"Cash recovery rate was 20.84% on average." What does this mean? It means that the AVERAGE can be measured to how many decimal points? 20.84 divided by 100. The only question is, how can anyone think that this number could be measured so accurately, even though it is well known that the numbers coming out of China are sometimes bogus? Deflated or Inflated. No one actually knows the true numbers. And, even if they did, no one would pronounce them with such certainty, to 0.xx Such precision is not even often available in real science, much less the bogus science of economics. True? By Breaking Bread - 8/28/2008 3:28 AM

Breaking Bread, I have no idea if they made up the number. However 20.84% should be the result of total cash recovered divided by the book value of the NPL disposed. It is really just an accounting ratio. By fatbrick - 8/28/2008 3:51 AM

The point being, that anytime one adds a couple of numbers behind the decimal point, especially when speaking of percentages, it does seem to state loudly that one has extreme confidence in the precision of the numbers that one is quoting. Which, as you say, is not really the case. Where is it justified to speak in such precise terms, down to the hundredth of one percent? There are many cases. For example, if one were to focus the Hubble Telescope on a particular star, and then be wrong in the angle of viewing by about 0.01%, then one would not achieve ones desired goal. The star would not be visible. However, to speak about Cash Recovery rate, and then stipulate that this rate is accurate to the hundredth of a percent, just might be taking economics theory to a far new level, never approached before. By 5Loaves2Fish Feed5K - 8/28/2008 7:04 AM

BB: Such precision is not even often available in real science, much less the bogus science of economics. True? When my bank gives me a monthly statement for my checking account or my credit card bill, the numbers involved are accurate to one cent. If I notice that the numbers are off, then I call them up. The numbers involved in calculating those ratios are like entries in one's checking account or the tab that one runs up in a restaurant. You have the precise value of the loans which were transferred from the banks to the AMC's. You also have the precise value that those items were sold at auction. Assuming these were all cash transactions, there really is no room for argument as to what those numbers are. I can tell you to as many significant figures as you want, what percentage of my credit card bill last money went to books or what fraction of my paycheck goes to taxes. Also we are dealing with big numbers. +/- 0.05% works out to about +/-US$100 million. It's not implausible to me that the accounting in the AMC's is good enough so that there was +/-$100 million in missing cash, someone would notice. There are areas where you end up with fuzzy numbers, but in those situations you can figure out what the cause of the fuzziness is. For example unemployment rates in China or NPL's in China in the 1990's tend to be very fuzzy because it's hard to define "employment" or "non performing loan." The stated value of the assets and the amount they they were sold for at action. There isn't much room for argument as to what those numbers. Now whether or not the stated values and the cash recovery rate matchs the actual value of those assets is another issue, but it's sort of irrelevant. By Twofish - 8/28/2008 8:25 AM

You may be arguing past each other. Dividing one precise number by another precise number can legitimately give us a number that is calculated to several decimal points. However BB's point, that 20.48% may imply a precision that is unwarranted, is also true. Using Fatbrick's numbers I think the best that can be said is that the recovery rate is roughly 20%. The fact that about 30% haven't been recovered might imply, by the way, that these are the most difficult parts of the loans to liquidate, and so the real recovery rate for all the NPLs can be as low as 14%. By Francois L. - 8/28/2008 12:45 PM

Is there a link between the persistent decline in the CSI (against BUY exhortations from Rogers etal) and the bad loans piling up on Chinese bank books? In 2005-2007 period when the "printing presses" were in full swing, Bear-GS-MS et al placed over 100b of the truly toxic stuff in "Chinese hands", now burning a hole...compounding the problem is the OTC "credit-default" swap mkt which allows "cowboy giants" like Paulson and Falcone to even bring a Bear to its knees.. By pravin - 8/30/2008 9:14 PM

What is the purpose of this blog? Is it to engage in some sort of esoteric self stimulating minutia, debating high school economic issues? Or is it to state something profound about the China economy which has not thus far been picked up by the mainstream and can be worthily quoted by people such as the plagiarizing and paid business/economy correspondents at Newsweek and Bloomberg? Or, is the purpose of this blog to comment on Jimmy Page? For his being “unknown” in China? Or, on Sympathy for the Devil, the poor guy who chickened out of running the hurdles, when he knew he would bomb out and let down 1.5 billion countrymen, and then farced it up to duck out of a race which would make him look like duck soup? The purpose of this blog, is whatever the instigator of this blog might say it is. Does this mean that the readers of this blog need be satisfied reading commentary by the blogger while the blogger sticks to a completely Ivory Tower mentality? Of course. But, anytime the readers of this blog want to get out of a true Ivory Tower point of view, then there is the option of plugging in REAL WORLD values into the economic equation. What might these real values be? For one, there are feedback variables, such as valid environmental variables which are now impinging upon the outcome of the very economic measurements that this blog is talking about, day by day. By Proust - 8/31/2008 12:57 AM

Proust, the purpose of this blog is, in your words, "to engage in some sort of esoteric self stimulating minutia, debating high school economic issues." I am really not interested in being much more profound than that. I have had to erase some of your comments because they are trite and irrelevant. Please stick to the topic. It would also be nice if you stuck to one name. Since you obviously like writing extensively about such profound issues I would invite you to present them in a more sympathetic location. Pravin, there is a probably a link but it is very unclear to what extent Chinese banks have toxic assets of the sort you mention. I suspect that lack of transpatrnecy is itsellf part of the reason for the market decline. By Michael Pettis - 8/31/2008 1:47 PM