2015-04 Book Review

Book Review: Money and Monetary Policy in China, 1845-1895, by Frank H. H. King

It seems as though every book written on money in modern China cites Frank H. H. King’s Money and Monetary Policy in China, so it is worthwhile to go back directly to the source. Readers should be prepared for a very dry, academic book with a level of detail that will test their determination towards the subject.

The title of the book should have been Monies and Monetary Policies in China, meaning the plural as opposed to the singular form. Professor King rightfully notes that “the phrase ‘Chinese economy’ may be misleading,” (p. 20) and “the Chinese monetary system was, in reality, several systems with many common features” (p. 43). Chinese monetary uniformity during that time is wishful thinking started by foreign traders in China, who despised the transaction costs involved with interregional trade, and carried on by contemporary scholars, who have come to the realization that without it their work on early Chinese currency is either one system inaccurately applied to the whole country or an analysis that is so specific to a single region that it is hopelessly irrelevant.

Professor King’s attention to detail in regards to weight, composition, and fineness in currencies issued throughout the country is helpful to scholars on the subject as reference material, but does not make for leisurely reading. In some cases, Chinese monetary units or institutions are referred by a romanized version of their Chinese name. Unfortunately, Wade-Giles Romanization, the system used in the book, is no longer in use. Anyone that learned Chinese on the Mainland after 1958 or outside of China after the 1970s is stuck constantly flipping to the glossary in the back.

Considerable attention is given to the issue of foreigners and foreign money in China. Professor King wrote: “It is in the treaty ports, however, that the problems and developments of most significance in the economic history of China take place […]” (p. 164). The reader is left wondering why the author decided to wait to discuss issues that in his view were most significant problems and developments until well into the second half of the book. The author’s view on the significance of foreign involvement is contradicted by his belief in the introduction that “up to 1895, the accumulated impact of trade, war, diplomacy, missionary activity, and constant foreign pleading for modernization had achieved very little, particularly if Japan be used as the measure” (p. 12). Although foreign coins, banknotes, and banking institutions were models of modernization, none were necessary for a country that was mainly based on barter and an immobile population.

The book has been out of print since it came out in 1965, so readers are limited to used copies. Hopefully a revised addition with Wade-Giles substituted for Hanyu Pinyin becomes available. If that happens, read it.

2015-04 Relative Equity Trends

In April, both the materials section and the consumer goods sections saw tremendous gains as both sectors were lifted by higher equity valuations.  The materials sector appreciated 48.63% since a year ago, which was higher than the 9.89% appreciation saw in the consumer goods sector.  This trend would indicate that the economic expansion that began in June, 2014 is continuing.

The big news in April was the fact that PetroChina saw the lowest profit margin in history.  According to Bloomberg, “Net income at China’s biggest oil and gas producer fell 82 percent to 6.15 billion yuan ($991 million) from 34.2 billion yuan a year ago[.]”[1]  Despite that, “Exxon’s capitalization was $352.6 billion through [April 8, 2015], compared with PetroChina’s $352.8 billion as of 1:36 p.m. on Thursday in Shanghai. The Chinese company’s A shares surged about 61 percent the past year, versus Exxon’s 14 percent drop.”[2]  PetroChina is now more valuable than Exxon Mobil.

In the future, we will look back on this event as a prime example of resource mis-allocation and animal spirits driven entirely by reckless central banks.

2015-03 Interest Rate Trends

In March 2015, both the short-term state-sector and long-term private-sector interest rates decreased. The overnight Shanghai Interbank Offer Rate (Shibor) ended March at 3.18%, a lower rate than the 3.44% seen in February. However, the spread between March’s rate and the trailing average for March was 108 basis points, slightly higher than the gap seen in February. Even though the rate dropped month-over-month, it is still high for March.

The Wenzhou Comprehensive Index ended March at 19.00%. That is 74 basis points lower than February’s close. The spread between March’s number and the trailing average was -93 basis points, which is higher than the rate seen in February.

Both rates are dropping, but the long-term private sector rate is dropping faster than the short-term state-sector rate. The convergence trend seems to be continuing.

2015-03 Relative Price Trends

Consumer prices increased 1.40% year-over-year in March, whereas purchasing prices fell 5.70% over the same period.  Based on this metric, China is in its 40th month of economic contraction.
The consensus seems to be that the market is misbehaving and can only be brought back under control by the central bank.  Alternatively, the central bank is misbehaving and can only be brought back under control by the market.  Deflation is not bad, it is simply a process to correct mistakes made in the past.  A Reuters article touched upon this issue, but missed the point.

Policymakers have publicly expressed worry that the risk of deflation is rising for the world’s second-largest economy, as the drag from a property market downturn and widespread factory overcapacity is compounded by an uncertain global outlook and soft commodity prices.

No mention is made of the factors that caused an overheated property market and excessive investment in factory capacity leading up to this moment.  There is some hope for financial journalism, because at least some positive aspects of deflation were mentioned.

[W]hile lower commodity prices have punished the extraction and power production sectors, the pain is not felt across the board, as some companies have taken advantage of lower input costs to maintain profit margins.

Unfortunately, influencers within the financial industry are either unaware of or reject the theory that money is not neutral.  Two representatives of Australia and New Zealand Banking Group made this ridiculous comment:  "[O]nly permanent liquidity injection will be able to sustain the current favorable monetary conditions to head off the risk of deflation."

2015-03 Stock Market Valuation

The Shenzhen Composite ended March at 0.26 gold ounces, up 0.05 ounces from February and up 102% from March of last year.  The index was trading at an average price-to-earnings ratio of 45.30.

March’s close, 0.26 gold ounces, was the highest price paid since September 2007.  The previous stock market bubble peaked out in August 2007.  There has now been 27 months of year-over-year positive price increases, the longest length of time for the data available.

The month-over-month increase in the gold price of the Shenzhen Composite was 23.13%, but the price to earnings ratio only increased 15.41%, meaning the impressive appreciation in stock prices was at least somewhat driven by earnings growth.  However, the last two times the stock market has hit these levels, a bull market that cut the value of the index by at least two-thirds soon followed.

2015-03 Book Review

Book Review: Economic Change in China, c. 1800-1950, by Philip Richardson.

How Europe, as opposed to China, came to dominate modern history is a debate that will not be settled any time soon. Professor Richardson’s book attempts to view this debate from the perspective of economic change.

In a story on economic growth, development, and change, the entrepreneur is the main character. Professor Richardson acknowledges that modern industry requires entrepreneurship to make headway (p. 62). The only other times entrepreneurs are mentioned, though, is to say that the government did not “create the context within which private entrepreneurs were able to respond effectively” (p. 84) and that “industrial modernization was considered too important to be left to private entrepreneurs” (p. 88). It is like Hamlet with scant reference to the prince.

Without a firm grasp on the causes of economic change, Professor Richardson can only tell the story of what happened, but not why it happened. These are two very different stories. The descriptions of economic trends in the book either lack vigorous analysis or contradict each other. One example of this is the typical inflationist viewpoint that falling prices are dreadful. The author cites other work showing that prices fell 40% between 1820 and 1850 (p. 22-23), drawing the conclusion that this was mostly the result of silver outflows due to trade. The author mentions the massive issue of paper currency (p. 19) and overstocking of ‘ever normal’ granaries (p. 22) before that period, but does not directly correlate these issues as possibly being the reason prices rose to an unsustainable level before 1820. This shows the author’s lack of understanding of money’s impact on the economy.

When foreign trade is mentioned, it is either considered favorable or unfavorable. All trade is favorable, the only defining feature of trade is whether it is free or unfree. Despite considerable discussion of interprovincial trade in agricultural goods, the author never draws the conclusion that trade between two provinces (i.e. domestic trade across internal borders) could be favorable or unfavorable.

None of the book’s citations are primary sources. Nor are there any citations of works in Chinese. Although Chinese scholars are cited, all of their works were written and published in English. Would a text written about early American development be taken seriously if no English language citations were used?

The book is a second-rate analysis of second-hand materials. The main body of text is only about 100 pages long, so it could pass as an introduction to issues related to economic change in China if the author had a solid understanding of entrepreneurship, monetary policy, and trade. That is not the case. Pass over this book.

2015-03 Relative Equity Trends

In March, the consumer goods sector and the materials sector continued their trends over the last few months.  The consumer goods sector continued to decline from a year ago, but the rate of decline over the last twelve months has slowed from -13.36% in February to -5.99% in March.  The materials sector continued to expand, and the rate of increase over the last twelve months has accelerated from 12.25% in February to 15.62% in March.  This indicator would indicate that the Chinese economy continues to be in a state of expansion that started in June 2014.

The end user prices for these goods contradict the movements in equities.  Raw materials and commodities prices have been declining over this period, whereas consumer goods prices have remained above negative territory.  However, equity returns for the companies that produce commodities have out performed equity returns of consumer goods sector companies.  This is most likely driven by the fact that new credit is flowing faster into the materials sector, which is further exacerbating the oversupply in raw materials.  The equity value of these companies is being driven higher as their investment in new assets further deteriorates their future cash flows, thus facilitating an even larger correction than would originally be required.

In the news:

• [SCMP] “Aluminum Corp of China Ltd (Chalco), the leading producer of primary aluminium and raw material alumina in the country, posted its largest-ever loss in 2014 due to huge writedowns and weak metal prices as the Chinese economy slowed.”
• [Platts] “With concentrate prices at current low levels, most of China’s molybdenum miners still in operations are incurring losses, an official from a major miner in China said on the sidelines of the 11th China Molybdenum Annual Conference that was held over March 27-29.”
• [Reuters] “China’s largest listed gold producer Zijin Mining Group reported net profit growth for the first time in three years in 2014 but expects gold prices to hover at low levels due to the global economy slowdown.”
• [Bangkok Post] “In Malaysia, Great Wall Motor Co Ltd (GWM), China’s biggest maker of sport utility vehicles (SUVs) and pickup trucks, has partnered with Go Automobile Manufacturing Sdn Bhd to invest 2 billion ringgit to assemble energy-efficient vehicles in Kedah state.”
• [Bloomberg] “China Mengniu Dairy Co. surged to a seven-month high in Hong Kong trading after China’s second-largest dairy producer posted full-year profit that beat analyst estimates.”
• [HKS] “China’s largest diaper maker Hengan International Group (1044) saw net profit rise 5.2 percent last year to HK$3.92 billion, thanks to a quick turnaround in the second half after a slip of 4.5 percent in the first.”