Trouble Brewing in China?

Posted: 6/25/2013 8:24:17 EDT

Chinese Stocks Close at Level Unseen Since Global Financial Crisis

Chinese stocks closed at a level unseen since the global financial crisis in 2009 on Tuesday, as analysts warned a liquidity squeeze was raising the risk of a hard landing for the world's second largest economy.

For more than two weeks, funds have been in short supply on China's interbank market and the interest rates banks charge to lend to each other have surged to record highs.

Instead of pumping money into the system, the central People's Bank of China (PBoC) has stood firm, on Monday ruling out providing fresh cash and ordering banks to put their financial houses in order.

"If prolonged, this may lead to a credit crunch to the real economy, risking a hard landing scenario in China," ANZ Banking Group said in a research report on Tuesday.

"The PBoC has already punished commercial banks for their past excesses. It is time for the central bank to restore confidence in China's financial system," it said.

Analysts said a deliberate policy of inaction by the central bank stemmed from worries over financial risk from loosely regulated wealth management products and the vast "shadow banking" system.

The liquidity tightness could persist to mid-July, they said.

"The longer this goes on, there's a risk that it could feed into the price of credit going into the real economy," said Paul Gruenwald, chief economist for the Asia-Pacific region for ratings agency Standard & Poor's.

"But for now, we don't see a measurable macro (economic) impact," he told a conference call with financial analysts and journalists.

A central bank official said Tuesday that liquidity risk was "largely" under control and the recent volatility in rates was likely to be temporary, Dow Jones Newswires reported.

China's stock investors have responded poorly to the moves.

The benchmark Shanghai Composite Index ended down 0.19 percent on Tuesday at the lowest closing level since January, 2009.

The index tumbled as much as 5.79 percent in afternoon trading before rebounding on bargain-hunting. The market closed down 5.30 percent on Monday.

"The situation with tight liquidity conditions has not improved," Zhang Yanbing, an analyst at Zheshang Securities, told AFP.

"The market is still anxiously waiting for authorities to improve liquidity conditions and stabilise the stock market," he said.

But in a stern warning for China's 170 million stock investors, the mouthpiece of the ruling Communist Party, the People's Daily, warned the government would not play "wet nurse".

"The securities regulatory commission is not the stock market's 'wet nurse' nor is the central bank," the influential newspaper said in a commentary.

"So-called market-saving and market-boosting acts will not help the stock market, rather they will harm the market," it said.

The handling of the liquidity squeeze has put the credibility of China's new leaders on the line as they try to control financial risks while at the same time keeping economic growth on track.

"The liquidity squeeze is the first real economic test for China's new leaders to prove their willingness to overcome tough economic issues not with words, but by their actions," said Zhang Zhiwei, a Hong Kong-based economist for Nomura Securities.

"If the new leaders maintain their current approach... it will add downside risk to growth in 2013," he said in a research report, though he added it would help make growth more sustainable in the long term.

China has set its annual economic growth target at 7.5 percent for all of this year.

The country's economy, a crucial driver of global growth, expanded 7.8 percent in 2012, its worst performance in 13 years.

Is China In Decline?

By Mark A. DeWeaver

SILVER SPRINGS, Maryland — Many Americans view China’s emergence as the world’s second largest economy with trepidation. The US, it seems, is in decline. China is a “rising power” destined to take over America’s role as global hegemon sometime in the not-too-distant future. 

Recently, however, China’s prospects are looking less rosy. First quarter GDP grew only 7.7 percent, down from an already subpar 7.9 percent in the fourth quarter of 2012. Exports are slowing and the investment-led growth upon which the country has relied in the past is clearly unsustainable.

Beijing is hoping to keep the economy on track by transitioning to a new “growth model” based on consumption and productivity gains. Yet so far there is little evidence to suggest that this strategy is working. Indeed, there is really no reason to believe that such a transition can be achieved under the country’s current political-economic system. 

As the Chinese juggernaut starts to lose momentum, should Americans be breathing a collective sigh of relief? Not really. Unfortunately, China’s decline is likely to be a lot less peaceful than its rise.

Slower growth will pose an existential problem for the Chinese Communist Party. Ever since the end of the Maoist era in 1978, economic development has been the party’s primary source of legitimacy.

A prolonged slowdown will weaken its hold on power in much the same way that crop failures during imperial times undermined the emperor’s claim to the “mandate of heaven.” If China is not going to be “number one” after all, some other justification for party rule will be urgently needed.

The party’s best bet will be to play the nationalist card, making the defense of the “motherland” its primary mission. This will not be difficult. It will be easy to blame China’s economic failures on the machinations of foreign powers, even as Mao Zedong did in his famous speech proclaiming the founding of the People’s Republic in 1949.

The fact that China had “fallen behind,” he said, was “due entirely to oppression and exploitation by foreign imperialism and domestic reactionary governments.”

It will also be easy to put the Chinese economy on a war footing. China’s central planning institutions are well suited to the mobilization of resources for defense industries. A military buildup would also help to alleviate excess capacity problems in heavy industry. Total excess capacity in the steel sector, for example, already exceeds total US capacity. Arms manufacturing is likely to be seen as a good way to put idle plants back online. 

The implications for China’s neighbors are already evident in Beijing’s increasingly bellicose insistence on irredentist territorial claims. There have been escalating tensions with Japan over the Senkaku Islands, spats in the South China Sea involving areas claimed by Vietnam, and even a Chinese incursion into an Indian-controlled Himalayan region claimed by both Beijing and New Delhi.

Such incidents are often described as competitions for the control of natural resources such as the South China Sea’s oil and natural gas. They are, however, better understood as consequences of the party’s domestic agenda. As public relations exercises they have been remarkably successful.

Chinese anti-Japanese sentiment is now at fever pitch, with many of China’s netizens expressing strident support for military action against Japan to recover lost territories, right historical wrongs and avenge past humiliations.
US policy makers need to realize that this type of nationalist sentiment is going to be the party’s ace in the hole once the economy slows.

Beijing can therefore be expected to prefer that international disputes remain unresolved. Its objective will be to keep the Chinese public distracted by possible foreign threats to China’s national security and economic development.

China, not the US, is fated to be the “declining power” for the remainder of this decade. This means that Washington’s preferred policy of “engagement” will not work. Beijing will be unable to give ground in disputes with its neighbors because doing so will weaken the party domestically.

Events like the recent summit between President Obama and General Secretary Xi Jinping are not going to improve US-China relations when the party’s survival depends on escalating tensions. 

Given that dialogue is likely to be ineffective, the US must focus instead on defending its strategic interests in the Pacific. It must continue to strengthen ties with its regional partners, particularly Japan and Taiwan, which are likely to be the main targets of Chinese military adventurism.

Most importantly, the US must avoid helping the party stifle demands for political reforms at home by handing it easy victories abroad.

Dr. Mark A. DeWeaver manages the emerging markets fund Quantrarian Asia Hedge in Silver Springs, Maryland, and is the author of Animal Spirits with Chinese Characteristics: Booms and Busts in the World’s Emerging Economic Giant.

© Global Post

Pesek: China Loses Control of Frankenstein Economy

Bloomberg View Columnist William Pesek writes:

The world has grown used to the idea that China’s leaders are masterful stewards of their gargantuan economy. They steered brilliantly around the iceberg of the 2008 financial crisis, maintaining growth of near-double-digit rates. So when People’s Bank of China chief Zhou Xiaochuan began clamping down on excessive liquidity last week, some observers viewed him as a Chinese Paul Volcker. Now that the worst was over, Zhou seemed to indicate, it was time for China to rein in lending and prevent a credit bubble from swelling.

Then reality intervened. After the overnight repurchase rate zoomed to a record 13.91 percent, Zhou had to back off, hastily injecting fresh funds to stem the turmoil. The chaos traumatized money markets. Some were dismayed by signs that Zhou would end the era of easy money in China. Others feared that he couldn’t.

Indeed, continuing unease this week underscores how limited Zhou’s powers actually are. Over the past decade, China’s economy has grown addicted to excessive credit growth, with state-owned banks encouraged to finance as many new skyscrapers, highways, airports, dams and ghost towns as needed to pump up gross domestic product. Free-flowing liquidity -- mostly to state-owned enterprises -- kept stocks and real estate buoyant, foreign investors bullish and China’s 1.3 billion people away from Tiananmen Square.

Continue reading.

60 Minutes on China's Real Estate Bubble

China's economy has become the second largest in the world, but its rapid growth may have created the largest housing bubble in history. Lesley Stahl reports.

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