Diamond Slice

China's Growth: Blessing Or Curse?

On a positive note for Japan, export growth in December surprised economists by growing at 12.1%, compared to the 7.6% forecast, for the first time since the collapse of Lehman in 2008. Breaking down the numbers, analysts were equally unsurprised to learn which market was responsible for the rapid growth. If I'm hitting my target audience, you've already guessed it... (hint: it starts with "Chin")

The half Joseph Stalin half Adam Smith economy continues to roar at 10.7% GDP expansion, in the final quarter of 2009, yet the majority of consumer markets have been slow to follow suit. Chinese stimulus can be thanked for the birth of domestic consumerism in China, as households have been given vouchers to buy specific goods, creating demand in centrally targeted industries. Simultaneously, all levels of government opened the faucet of liquidity, through low borrowing costs and lax loan requirements, which has accelerated the churning out of western style real estate for consumers to fill with all their new stuff. The price tag on China's stimulus so far scans just shy of $600 billion USD, representing 13% of GDP in 2008 and well above spending in the U.S. and Korea, closer to 5% of GDP for each.

As an Expat living in Korea, I can vouch for the tangible business and expansion that has been rumored to have begun in the East. The steady export market in China has buffered job losses and allowed entrepreneurs to take advantage of the record low interest rates which have spanned the globe. The result, through the eye of an American businessman, is a crane filled skyline in motion and downtown retail epicenters furious with life. It all seems eerily familiar to the consumerism evident in the U.S. circa 2004-2006, and is founded on an assumption perhaps less ridiculous than the "forever appreciating U.S. home price" fallacy, but equally as probable. The new assumption serving as the global economic engine, is that China's 10% growth is not only sustainable, but that it will occur for the foreseeable future. 

Let's look at some of this "sustainable" growth more closely: 

- 2008 China GDP = $4,327 Billion (World Bank)

- 2009 Unrevised China GDP = $4,910 Billion (China Daily)

- 2009 Q4 China GDP Growth = 10.7% (Xinhuanet)

- 2009 Outstanding Loan Growth = +$1,400 Billion = 28.5% GDP (2009 Est.) (WSJ)

- 2009 Broad Money Supply Growth = 27.7% (WSJ) 

- 2009 GDP growth = 13.5% (unadjusted for inflation)

Recently markets have operated under an irrational paradigm where prices don't move until the reality of the situation is forced down our proverbial throat. Ironically it seems that the rumors, fears, and speculation about asset bubbles in China are enough for the communist leadership to forcefully hit the breaks on loose liquidity expansion. The ICBC will curb lending in 2010 by 25%, no doubt to moderate the pace of inflation and domestic growth, as it out-paces the anemic recoveries elsewhere across the globe.

This idea that China saw peak economic acceleration in the last quarter of 2009 hasn't sat well with market movers. While stricter borrowing standards may benefit all, helping to avoid a collapse akin to the U.S. real estate failure, the return to reality has traders scratching their heads for reasons to buy. Added stress from a reversal in the U.S. housing recovery and a weak demand forecast from multinational Caterpillar (CAT) have contributed to the past week's decline. 

It's fair to say that the global recovery is fundamentally based on strong growth from China, while there is evidence that GDP growth in the cheap U.S. dollar-tied-Renminbi may be eroding sales from global competitors and misrepresenting global consumer demand. This week's negative outlook on Japan by Standard & Poors and manufacturing woes in Germany, beg that such fears are rooted in truth. Combining these symptoms with an autocratic body of leadership, resistant to allowing its currency to freely appreciate, has exposed the China led recovery to criticism.

It isn't hard to distinguish Asia's beating heart, albeit is any man's guess whether the continent's overall return to growth lives or dies. China is a formidable 1.3 billion strong populace, the world's third largest economy, and yet the IMF ranks the nation's per capita GDP 89th. As blind as justice, markets may now be signalling that the still developing nation cannot lead the globe from the stimulus injected foundations of recovery to global economic expansion. Whether they are right is up to each of us to decide.

Bernanke's Puppet Economy

With the autumn comes the brisk northern air that reminds us of the fragility of life and the strict laws of nature; lessons which most years occupy a few thousand microns of brain tissue as such trivial metaphysical notions pass under the radar of consciousness. Yet it seems that we humans subscribe to a separate reality where our man made organism known as the global economy can defy reliance on physical laws and balances among parties, contrary to the paradigm within which organisms share resources and life.

These days death is so 20th century, aging is "faux pas", and failure is completely unacceptable, thus we open up the hood and start pulling wires until we seemingly avoid these outcomes in the short run, leaving plenty of duck tape and WD-40 on the fender if anything should go wrong. 

The U.S. Fed Funds is at 0%, the U.S. Fed absorbed Fannie and Freddie (in effect adding the majority of the nation's housing debt to the Fed's balance sheet), tangible sovereign debt delinquencies are beginning to arise in Europe and the Middle East, and financial firms across the globe are continuing to buckle under the weight of more delinquencies and defaults. Consumer credit reaches new historical lows each month (a good thing in the long run), choking consumers to spend little more than they could in the midst of the market crash of 2008-2009. The dollar has fallen against most foreign currencies, until it's recent rebound on speculation of a Fed Funds raise, releasing cheap money to all of the guys on Bernanke's A list (A short list which excludes mall cap firms and fewer private enterprises).

We all know the story, we all see the mayhem of economic data when we glance in the rear view, we even all expected that the music would eventually stop and the economy would have to walk "freely" by itself. It's the classic leak stopping cartoon where a guy is using one hand to cover a leak in his boat but the pressure just causes another breach and eventually he's out of appendages, but in Bernanke's boat he continues to grow arms and continues to stop leaks. Bernanke is an extremely intelligent and creative regulator who continues to invent Monetary tools to make his puppet dance, but we need a "real boy" not a puppet. When Fed Funds at 0% failed, he gave the banks money to lend, when shareholders panicked he seized the GSE's and secured their mortgages, and now that carry trades have abused excess liquidity in the system he has decided to borrow the 0% money he lent to the "too big to fail" financial firms at a CD level premium. It's a financial shell game no better than a Ponze scheme and the longer it goes on the more money it's going to cost the taxpayers who still don't have jobs.

But it will go on, because that's what the boys upstairs have clearly decided will happen, so the excess liquidity in the system has been the most recent phenomena to be traded off of. The carry trade uses cheap U.S. dollars and invests in risky assets such as stocks, bonds, foreign firms, and commodities; allowing for a booming U.S. stock market among other things. Until the masses became privy to what was making the puppet dance and the carry trade discounted in, Bernanke could enjoy the time he'd bought, but despite the struggling economy it now seems that Obama and his Europe buddies have a new scapegoat for our troubles other than the Fed Chairman.

Relations between Obama's White House and Hu Jintao's Chinese Leaders have been tense at best, as the recent pectoral flexing and anticompetitive trade tactics are squaring Obama and his cronies up against the 1.3 billion strong communist nation. Now, calls for China to re-float the Renminbi (Chinese Yuan), after it was re-pegged to the U.S. dollar in August 2008, are becoming widespread as the economy is poised to grow at rates near 10% and it's cheap goods are undercutting domestic producers across the world. But the Yuan equals the same today in dollars that it did when it was re-pegged in 2008 and it seems that in true faith Obama could save a few taxpayer dollars on the long distance in exchange for a direct line to the Federal Reserve. Bernanke is just as responsible as Hu for undercutting foreign competitors as the U.S. dollar has depreciated relative to ALL global currencies besides the Yuan. Now we see the dollar rising as U.S. Treasury debt falls out of favor ahead of suspected Fed Funds hikes in 2010 and the Yuan will pop into higher territory right along with it. It would seem that world leaders should have called for a de-pegging from the dollar in December 2008 rather than the current level near rock bottom for the currency, but we digress.

We do see further dollar weakness as the initial Fed Funds Rate increases occur, should economic growth sputter. In this scenario there will be little upside potential for the U.S. dollar and the carry trade investments in U.S. assets will be far too risky, given the underlying weakness of American firms in such an environment. The potential for bond yields to rise and the dollar to fall a second time would be high in an environment where the U.S. government and private sector are both deemed poor refuges for individuals' cash. More immediately however, commodities will pull back as the rise of the dollar continues and the ability of gains to be made by U.S. investors amidst a rising dollar takes a great deal of money out of U.S. equities and into foreign stocks instead. We see this point as a good entry for short Oil positions and short U.S. equity positions.

Disclosure: Long SDS, Long SCC, Long DTO, Long TYO