China faces a difficult choice in 2010 as rapid loan growth, necessary to sustain the economy, may begin to fuel hyperinflation. In normal times, the Chinese government uses the banking sector to send masses of low-interest rate loans to companies and sectors targeted for growth. This maintains growth and employment levels, preserving social and economic stability in a country with a massive population.
In times of stress, this aggressive lending goes into overdrive. The year 2009 has witnessed an unprecedented lending-surge by Chinese banks, who, under government direction, hoped to stave off a recession in China’s domestic economy as exports to the U.S. and rest of the world plunged. This has been a dramatic success. For example, the data reported for the month of October was very strong:
- Growth of industrial value-added, which accounts for about half of China’s GDP, accelerated to 16% year-over-year.
- Electricity production, a good growth barometer, grew by 17% year-over-year.
- Steel production set a record 44% year-over-year gain.
- Retail sales increased 16.2% year-over-year.
- Vehicle sales totaled 1.2 million (more than the 838,000 sold in the U.S. in October).
China’s GDP
By the end of the year, the net new loans fueling this growth are likely to total more than $1.5 trillion, which would equal over a third of China’s GDP. In October, the money supply was up 29.4% year-over-year and bank loans were up by 34%. This is a massive lending spree, even by China’s standards. Much of the lending that was targeted to growth industries has leaked into the stock and real estate markets, which have rallied dramatically and are beginning to form bubbles. With subsidized loans still growing and the global economy now in recovery mode, the threat of double-digit inflation (already prevalent in India, another BRIC country) is looming.
Adding to the inflation pressures is the fact that with the yuan pegged to the dollar over the past year, the Chinese have seen their currency plunge against their trading partners. This has resulted in higher import prices for commodities. In an attempt to prevent this, authorities have tried to pull back on lending several times in 2009. Every time, sectors of the Chinese economy start to suffer after just a few weeks, and the government ramps new loans back up again. The Chinese economy is dependent upon exports. While the decline in China’s exports narrowed to -9.1% year-over-year, from more than -20% earlier this year, it is still falling. If monetary and credit policies remain unrestrained, asset prices will continue to inflate and inflation will pose a major problem.
In the past, China’s CPI has been forecasted by commodity prices, money supply growth, and the value of the yuan versus the dollar. A simple inflation regression model using these three inputs, leading by 6 months, has a very good record of forecasting CPI and is currently pointing to over 10% inflation by the second quarter of 2010.
China’s Challenges
The challenge facing Chinese authorities is how to bring lending down to sustainable levels and tighten monetary policy without sending the economy into a tailspin with global implications. China’s authorities can either cutback on lending to curb inflation and risk social unrest and an economic slowdown or wait until exports pick up again at the risk of double-digit inflation. So far, it appears that the Chinese authorities lack the desire to rein in growth, and may continue to fuel the rise in asset prices and inflation into 2010, while the pace of inflation remains subdued.
Therefore, in the near-term, the tailwinds of growth are likely to continue to support strong performance in emerging Asia; but the consequences of high inflation on labor costs and consumer spending may require action by mid-2010. If China begins to rein in stimulus mid-year they will likely be in accord with the rest of the world, as the U.S. Federal Reserve is likely to join Australia, Canada and other central banks in hiking rates around the middle of 2010. This globally synchronized, tighter monetary policy could result in a global economic slowdown in the second half of 2010 after a strong start.
IMPORTANT DISCLOSURES
- This was prepared by LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your fi nancial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
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{ 1 comment }
I just attended an economic conference and they were talking about the differences between China and USA.
They were showing how fast their economy was growing compared to developed and industrial countries.
I’m only worried about the fact that their government is also stimulating the economy right now and the Chinese consumer is not following the rhythm.
Mike @ Gather Little by Little´s last blog ..Insider trading and why you must avoid it!
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