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China Syndrome: Supercharging the Recovery


Speculative stockpiling is artificially boosting demand.

Editor's Note: This is Part 2 in a multi-part series. Click here for Part 1.

Fall and Rise

In 2007, unsustainable levels of debt in many economies triggered a near collapse of the global banking system that, in turn, triggered a major slowdown in growth.

The unprecedented external demand shock, with sharp decreases in consumption and investment from synchronous deep recessions in the developed world, affected the Chinese economy. The sudden and precipitous fall in exports led to a significant slowdown in China's stellar growth rates in 2008, triggering sharp declines in stock and property markets.

Job losses in export-intensive Guangdong province were in excess of 20 million migrant workers. Workers and students entering the workforce were unable to find work. Fearful of social instability, the Beijing government moved quickly to restore rapid growth.

Panicked government spending and loose monetary policies increasing available credit is currently driving China's recovery, contributing around 75% of China's growth in 2009. In the June 2009 quarter, Chinese exports (around 35-40% of the economy) decreased by around 20%, implying that the non-export part of the economy grew strongly.

In the first half of 2009, new loans totaled over $1 trillion. This compares to total loans for the full 2008 year of around $600 billion. Current lending is running at around three times 2008 levels and at a staggering 25% of China's GDP.

The availability of credit is fueling, in part, speculation in stocks, property, and commodities. Estimates suggest that around 20-30% of new bank lending is finding its way into the stock market, driving up values.

Record numbers of new trading accounts have been opened, including over 500,000 accounts in one week in July alone, the highest since January 2008.

The market for initial public offerings for new companies has recommenced after being closed for six months. In 2009, issues have been massively oversubscribed and risen sharply on listing.

In July 2009, on the first day of trading, shares in China State Construction Engineering, the country's largest homebuilder, rose by as much as 90%, closing up 56% reviving memories of the heady days of the previous boom. The shares in Sichuan Expressway tripled on debut before closing up over 200%. The frenzy has also affected Hong Kong, where China-related stocks have risen strongly.

In the second half of 2009, the equity market slowed down and new issue performance was more variable. Many new issues started trading below their issue prices as investors became more circumspect.

China's recovery, in turn, underpinned the recovery in commodity prices and economies dependent on natural resources. In recent parliamentary testimony, Reserve Bank of Australia Assistant Governor Philip Lowe highlighted the extent to which Australia, a major trading partner of China, was reliant on Chinese demand. Lowe noted that 23% of Australia's total exports went to China in the most recent quarter, up from 4% 10 years ago. China now also takes 80% of Australia's iron ore exports and 20% of coal exports.

While a significant part of the importation of commodities is restocking depleted inventory, abundant and low-cost bank finance combined with a deep-seated fear of the long-term prospects of US Treasury bonds and the dollar has encouraged speculative stockpiling, artificially boosting demand.

Lock and Load

Government spending and bank loans have resulted in sharp increases in fixed asset investments (over 30% up on 2008). A major component is infrastructure spending, which accounts for over 70% of the Chinese government's stimulus package. In the first half of 2009, investment accounted of over 80% of growth, approximately double the 43% average contribution over the last 10 years.
No positions in stocks mentioned.

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