Monday, August 24, 2015

Public Comments for Future Review, 2015-08-24

"It's totally premature to speak of a crisis in China," [Carlo Cottarelli, an IMF executive director representing countries such as Italy and Greece on its board] told a press conference. 
He reiterated an IMF forecast for a 6.8 percent expansion in the Chinese economy this year, below the 7.4 percent growth achieved in 2014.[1]

Sunday, August 23, 2015

2015-07 Interest Rate Trends

In July, the state-sector and private-sector interest rates showed divergent trends, for the benefit of the private sector.

The Shanghai Interbank Offer Rate (Shibor) ended July at 1.47%, which was a 43 basis point increase from May.  However, that is still 108 basis points lower than the trailing average for July.  The cost of financing for state-owned banks is increasing, despite the amount of new money that is being created by the central bank.

By comparison, the Wenzhou Private Finance Index ended July at 18.08%, the lowest rate in the series.  It may be that as private lending is liberalized more financial capital is being allocated to the private sector.  Or, it may be that financial repression by the central bank and the collapse in equities and real estate prices has led an unsustainable amount of funds seeking yield into riskier assets.  Probably both.

Sunday, August 16, 2015

2015-07 Relative Price Trends

Consumer prices in China increased 1.6% in July from a year earlier.  Purchaser prices declined -6.1% over the same period.  Two divergent trends are occurring for China's structure of production.

The rate of increase in consumer prices is accelerating.  The rate of increase hit a most recent low point of 0.80% in January, 2015.  Since then, the growth rate has mostly been accelerating, especially over the last three months.  In May, the rate was 1.20%, but has gained twenty basis points every month since then.

The rate of decrease in purchaser prices is also accelerating.  The extent of the decline in July was the largest since October, 2009.  Even though the central bank is pumping money into the economy to increase overall economic activity, the only effect it seems to be having is to make life more expensive for everyday people.

It will be interesting to see how the recent devaluation affects these prices.  China does not import many consumer goods, so the devaluation will not affect the Consumer Price Index much.  China does import most of the world's commodities, so they devaluation should be directly reflected in the Purchaser Price Index.

Friday, August 14, 2015

Investment in Overcapacity, Consumption of Depleted Resources.

China Daily quoted Tianyong Guo, head of the Chinese Banking Industry Research Center at the Central University of Finance and Economics in Beijing, as saying: “A great amount of capital has enteredthe equity market and squeezed capital for investment and consumption, resulting in insufficient investment in the real economy and a contraction in demand.”

The authors’ observation was: “[T]raditional sectors such as steel, cement and power industries are struggling with difficulties such as overcapacity, rising costs, and depleted natural resources.”

If the pillars of the Chinese real economy (i.e. steel, cement, and power generation) are experiencing overcapacity, why invest in more capacity? If natural resources are being depleted, why should demand expand further?

Another question to ask is what is driving costs higher? According to the front-page article on the Business Section of the China Daily on July 28th, interest payments of industrial companies dropped 6.2% after three cuts in benchmark interest rates. Commodity prices have also been falling consistently. The only other major cost would be labor. Are industrial companies expanding their workforces to offset layoffs in other sectors of the economy? Is the Chinese labor market worse that it appears?

Thursday, August 13, 2015

Yanghangese: China’s Fedspeak.

On July 29, 2015, China Daily reported on the statement made by the People’s Bank of China the day before. The statement claimed that the central bank would “continue a ‘prudent’ monetary policy in thesecond half [of 2015] while maintaining proper liquidity to stabilize financial market expectations, reducefinancing costs, and keep a stable currency exchange rate.”  Many of the adjectives used in the statements are great leaps of faith in the institution of central banking.

Fedspeak is an English word for the intentional wording of Federal Reserve statements in a manner that could cause different market participants to come to completely different conclusions on the direction offuture policy. The word for central bank in Mandarin is zhōngyāng yínháng, often shortened to Yāngháng when referring specifically to the People’s Bank of China. Given the habit of ending Asian languages or dialects (Japanese, Cantonese, etc.) with the suffix –ese, the Chinese equivalent of Fedspeak would be Yanghangese.

In the statement quoted above, one person’s understanding of the words “prudent”, “proper”, and “stability” are quite different than the intended meaning of those words in the context of Yanghangese. In Yanghangese, the definition of a “prudent” monetary policy is the same monetary policy that initiatedthe largest single-country stock market bubble in history. This policy will be continued, despite the consequences. Similarly, the Yanghangese meaning of “proper” liquidity means whatever amount of liquidity is needed to re-inflate the stock market to its previous high and continue the upward trend in equity prices for at least the next 5,000 years of Chinese civilization. The central bank has facilitated greater inflation in the domestic money supply and pushed interest rates lower against the general trend of higher interest rates in the developing world. Maintaining the exchange rate at about ¥6.2 against the dollar has led to a dramatic decrease in foreign exchange reserves as capital leaves the country. As foreign exchange reserves decrease, more capital will leave the country in anticipation of a greater devaluation than otherwise would have occurred. This will become a self-fulfilling prophecy, but in Yanghangese this arrangement will lead to the maintenance of a “stable” exchange rate.

A proper translation of Yanghangese based on the central bank’s announcement should lead us to expect imprudent monetary policy that will deliver excessive liquidity and higher volatility in the exchange rate value of the renminbi.

Tuesday, August 11, 2015

Yuan Devaluation Causes Offshore Financing Costs to Spike.

The yuan devaluation on August 10, 2015 was the largest single-day devaluation since 1994.  According to the Wall Street Journal, the daily fix was increased from 6.1162 on Monday to 6.2298 on Tuesday, representing a 1.9% devaluation.[1]  What does that mean for China's offshore debt market?

According to Bloomberg, China's corporations have $529 billion worth of offshore debt.[2]  On Monday, that was worth ¥3,235 billion.  On Tuesday, that was worth ¥3,295 billion, representing a ¥60 billion increase in principle.

According to another Wall Street Journal article, the average interest rate for offshore Chinese debt is higher than 8.00%.[3]  At 8.00%, the $529 billion debt burden would require $42.32 billion in interest payments every year.  On Monday, those interest payments were worth ¥258 billion, but by Tuesday had increased to ¥263 billion.  Overnight, the cost of offshore financing for Chinese companies increased by five billion yuan.  Each news article indicates that Chinese companies have not hedged against currency fluctuations.

Sunday, August 9, 2015

2015-07 Stock Market Valuation

In July, the gold price of the Shenzhen Composite fell for a second straight month.  It is now back to where it was in April, but still up 112% over the previous twelve months.  The closing price for July was 0.31 gold ounces, down 0.03 ounces from June.

Up until very recently, all of the factors related to viewing the value of the Chinese stock market in this way were falling into line to inflate the index.  Most importantly, the valuation of Chinese equities was increasing.  After ending 2014 at 34.05 times earnings, the price-to-earnings ratio peaked out on a month end basis at 61.41.  Second, the U.S. dollar price of gold has been declining for four years.  Lastly, the exchange rate with the U.S. dollar has remained stable.

In the coming months, the cashflows of Chinese equities will be further discounted, gold will resume its bull market, and the renminbi will devalue significantly.