China’s Catch-22

I considered the title “bad news is good news” but it seems the phrase ‘Catch-22’ from Joseph Heller’s book is more appropriate. A dictionary describes it as “a problematic situation for which the only solution is denied by a circumstance inherent in the problem or by a rule.” For example, (from the book as I recall it) say a pilot pretends to be crazy to get out of military service altogether. The very motive – wishing to avoid combat and stay alive by pretending to be insane – is the antithesis of crazy, proving he is quite sane indeed.

China’s situation is similar. It may very well seem sensible at this stage for the Chinese government to aggressively create liquidity and stimulate growth – following in the footsteps of North America and Europe.

This quote is from the Business Insider’s The Closing Bell summary for 24 June, 2013:

The sell-off really started in China, where the Shanghai Composite fell 5.2%, sending the index into a bear market. This was triggered by hawkish comments from the People’s Bank of China, which refuses to ease up despite surging interest rates. Here’s Nomura: “The guidance note stated that “overall bank liquidity conditions are at a reasonable level” and asked banks to “prudently manage liquidity risks that have resulted from rapid credit expansion”, “appropriately contain the pace of loans and bill financing” and “utilize the stock of money and credit to support the economy.”

Seemingly prudent, the result is a very real slowing of economic growth. I agree that China is being prudent but because they have no real sensible alternative.

China owns 1.2 trillion of $US debt securities. In fact China holds 7.5% of all US government debt. Since the entire Chinese GDP is $US 8.2 trillion then its investment in United States treasuries is a hugely significant asset equal to 15% of their country’s total wealth.

Deliberately depreciating the renminbi (RMB) in order to fuel economic growth would seriously bolster the value of the those US assets held in such abundance, and provide a shot it the arm to exports as well. But now that China is doing so much international trade with the U.S. and especially Europe, this sort of government initiative would simply damage those stumbling economies and encourage those who would introduce politically-motivated barriers to trade.

On the other hand, doing Obama a good turn and allowing the RMB to appreciate in value would hurt the value of those assets and slow down what growth is already occurring.

The Catch-22? Doing either would not result in the desired outcome. Staying the course means the RMB can depreciate at a lacklustre (non-threatening) pace, and nobody can blame the government for excessive stimulus. Strangely, the RMB is depreciating despite what can only be interpreted as a prudent economic policy. Normally, such an approach should cause their currency to strengthen but instead in May alone the RMB depreciated 0.9% against the Greenback. Chinese economic policy plays right into Obama’s hands; even if the end result is not what should happen. Bottom line is you can’t blame them for not trying.

Chinese Proverb: Do not fear going forward slowly; fear only to stand still.

In my book Resources Rock (Insomniac Press 2004 with Pamela Clarke) there’s just a hint of the ingenuity and doggedness China demonstrates when it comes to business. There was a ‘raging bull market for fertilizer stocks between 1993 -1996′.

“China imported huge quantities of fertilizers, primarily urea and DAP, to support new policy initiatives designed to move the country towards agricultural self-sufficiency.”

but in due course,

China used to consume 20% of the nitrogen fertilizer produced in North America. But by 2000, the Chinese banned urea fertilizer imports, and instead became a leading producer of nitrogen fertilizers.”

The Chinese have always been calculated and patient. As I mentioned in my previous commentary: China will be the next big surprise! By doing nothing at present (the only path available) inflation remains controlled, their housing bubble stalls and thanks to a modestly depreciating currency exports and economic growth will gradually resume. Do not fear going forward.

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