Manas Chakravarty: When China sneezes, commodities catch a cold
Will the Chinese investment bubble burst or gently deflate?
| At the same time, aluminium inventories on the London Metal Exchange (LME) jumped 2.5 per cent, their highest rise in over a year. That was enough to re-ignite concerns about a slowdown in the Chinese economy, sending commodities reeling on the LME and on the New York Mercantile Exchange, where December copper futures fell 11 per cent, its biggest tumble since 1990. |
| Other commodities soon caught the contagion, and nickel prices in London had the biggest drop in 16 years, while aluminium, zinc, lead and tin prices also plunged. |
| On Thursday, markets across Asia tottered, metals stocks plummeted, and the Chinese stock market fell to a one-month low. The Morgan Stanley Capital International (MSCI) index tracking material stocks in Asia shed 2.7 per cent, its biggest drop in four months. |
| Back home, the BSE Metals index fell by 4.6 per cent, pulled down by stocks such as Hindalco, Nalco, Sterlite Industries, Sesa Goa and the steel and sponge iron manufacturers. Even shipping companies were hurt, on the expectation that lower Chinese demand would hurt freight rates. |
| To be sure, there had been frenzied speculation in metals earlier in the month, which had sent them to multi-year highs. Copper had touched a 15-year high a week ago. Hedge funds had been busy piling on to commodities, and when they took profits, prices crashed. |
| The Chinese slowdown |
| But was speculative activity solely responsible for the sharp drop in commodity prices last Wednesday? Significantly, the Chinese Customs Bureau said on Thursday that imports rose 22 per cent year-on-year in September, the slowest rate of growth in two years. |
| That's a substantial climb-down from the 36 per cent import growth in August, and it has happened despite soaring oil prices. Could it be that this time the long-awaited slowdown has finally arrived? |
| Chinese money supply figures for August showed M2 growth at 13.6 per cent, the slowest growth in two years. In September, money supply increased by 13.9 per cent. |
| That's an indication that the Chinese central bank's savage credit control measures are finally working, squeezing credit growth and money supply. |
| There are other straws in the wind. Fixed asset investments grew 30.3 per cent, year-on-year, in August, compared to a growth rate of 34.8 per cent in May. China's imports of steel products fell 15 per cent in the first nine months of the year. |
| The stockpile of unsold new cars rose to 400,000 by the end of August. And this time the Chinese government may not have to do much to cool the economy "" soaring crude oil prices could do that more effectively. |
| The bubble |
| Perhaps more importantly, the Reuters story about the fall in metals prices in Asia had the reassuring line, "Analysts said that China's bubble had not yet burst." That's an explicit admission that the frenetic investment activity in China is nothing but a giant bubble. |
| Why is it a bubble? Last month, when Morgan Stanley's chief economist Stephen Roach was in Mumbai, the title of his presentation was "Global Rebalancing""Now or Never?" Roach and other economists have been drawing attention to the fact that the world economy today is one where, essentially, China produces and the US consumes. |
| While Americans live far beyond their means, gorging on debt and going on shopping sprees, diligent Chinese, often working 12 hours a day, seven days a week, churn out the goods that Americans buy. While the US is neck deep in debt, the Chinese save as much as 40 per cent of their income. |
| This imbalance in saving and consumption is reflected in the macro numbers. The US current account deficit, which measures the excess of goods and services that Americans import over exports, has risen to almost 6 per cent of the US GDP. |
| The August trade deficit in goods and services was 6.9 per cent higher than a $ 50.5 billion imbalance in July, with the deficit with China climbing to a huge $ 18.1 billion. The consequence "" a record $ 515 billion in forex reserves with the Chinese central bank. |
| What does the Chinese central bank do with its dollar hoard? Why, it lends it right back to the US, investing in its Treasury bills. Currently, about 40 per cent of the entire supply of US treasury bills is held by Asians. |
| This flood of dollars pouring into US bonds bids up their prices and keeps their yields low. That's why, in spite of a high fiscal and current account deficit, in spite of very high debt levels, interest rates in the US continue to remain so low. |
| That helps US consumers continue to splurge with their credit cards and mortgages, which, in turn, leads to more demand, which Chinese imports satisfy. Chinese factories hum with activity, while Americans shop till they drop. |
| It's an arrangement that suits both sides. But as Roach has pointed out, "the world economy currently is being supported by only two growth engines "" the Chinese producer on the supply side and the American consumer on the demand side. The real problem is that both of these engines are now at serious risk of sputtering". |
| What's more, both the US consumer and the Chinese producer are inextricably linked "" the consumer dependent on low interest rates made possible by the Chinese (and Japanese) central banks recycling dollars back into the US, and the Chinese producer dependent on the US consumer for his exports. |
| And overseeing this increasingly dangerous game is the US Federal Reserve, which has, by keeping interest rates extremely low, created a debt bubble in the US that is matched by an investment bubble in China, and especially, by the bubble in property prices in cities like Shanghai. These bubbles are Siamese twins. |
| Will the bubble burst? |
| The big question, of course, is whether the bubbles will burst, or whether they will gently deflate. Opinion is heavily in favour of the soft-landing scenario, the latest supporter of that view being the Asian Development Bank (ADB). |
| What do the Chinese say? The spokesman for the State Development and Reform Commission recently said that while the macroeconomic control measures the central government has been implementing have been working, many of the problems that caused parts of the Chinese economy to overheat were still there. |
| The People's Bank of China governor recently told reporters that although macroeconomic control measures have taken effect, pressure from fixed-asset investment and inflation has not eased. |
| In other words, expect more tightening in the days ahead. But state officials have also said that they expect inflation to slow in the fourth quarter. |
| So what kind of a landing are we looking at? China's GDP growth was 9.6 per cent in the first half of the year, and the third quarter is expected to see a growth of 8.9 per cent. For the current quarter, economists expect a growth rate of 8 per cent. |
| If that's a landing, most economies would be glad to remain grounded. The ADB report predicts that China's imports will increase 30 per cent this year and 20 per cent next year, and growth in investment will remain high at 25 per cent this year and 21 per cent in 2005. |
| Nor has there been any slowdown in foreign direct investment in China. FDI was $ 48.69 billion in the first nine months this year, up 21 per cent year-on-year, according to the ministry of commerce. |
| And metal companies pooh-pooh all talk of a slowdown, pointing out that the Chinese government is also encouraging expansion of power generation and transmission and other projects that use copper, steel, aluminium and other metals. |
| In other words, a landing of this kind would be no cause for panic, and commodity suppliers can breathe easy. And if China is slowing, why are crude oil prices going through the roof? |
| On the other side, of course, are those in the hard landing camp, who believe that a bubble of such large proportions can only be pricked and not deflated. These economists say that with so much excess investment, a hard landing is inevitable. |
| Meanwhile, as events last week demonstrated, all this uncertainty will ensure that markets across the world will shiver every time China catches a cold. |