China, Inflation and A Potentially Rocky Road Ahead

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Exports, Imports, Macroeconomics

President Obama’s actions to reign in the activities of the banks and China’s increase in bank reserve requirements have had a sobering effect on the markets. Both equity and metal markets have come off their highs and made investors pause for thought. The approaching Chinese New Year is also casting a damper on the Asian markets as no one wants to build a position, one way or the other, prior to a prolonged holiday.

So an article in Mineweb this week written by Simon Hunt founder of metals analysts Brooke Hunt in the 1970’s and now owner of Simon Hunt Strategic Services makes sobering reading whether you agree with all his conclusions or not. The gist of the argument is that inflation is becoming a problem in China and because of China’s preeminent position driving demand in the post recessionary world, if China stumbles we all fall.

First, the inflation element. The article states that there has been an extraordinary rise in liquidity in China with outstanding loans rising by 32%, M1 (narrow measure of money supply) by 32% and M2 (broader measure of money supply) by 28% last year, about double the growth rates seen in 2007, the growth peak of the last cycle. Last year, every 1RMB growth in GDP required a lending increase of 5.3RMB against a historic average of closer to 1.3.  Input prices are rising for manufacturing the article says; export prices are being forced higher across many products by an average of 10% with effect from January this year. With the economy being actively driven towards personal consumption and with so much liquidity in the system it is no surprise the housing market is experiencing inflation. Real estate prices are soaring according to many private sector (but unnamed) sources with prices in Shanghai and Beijing increasing by over 60% last year and by 80% in Shenzhen in December versus a year ago. Even the governments’ own housing index is showing an increase of 7.8% nationally in December 2009. There seems a huge disconnect between these unnamed sources and the government index but even half way between the two is a scary number.

The second issue is how do the authorities manage to reduce this surplus without causing a crash? Clearly they see inflation as a problem too, hence the increase in bank reserve requirements intended to take liquidity out of the market in gentle steps. There will be more of these gradual tightening moves intended to slowly take the froth out of speculative bubbles such as the housing market and inventory building. Simon Hunts’ position is it won’t work. His prediction is he expects to see the Shanghai stock market beginning a sharp fall over the next two months, the size of which will surprise analysts, a fall which should last until around the autumn, one that should be deep and serious. Moreover, actions now likely to be taken by the Obama Administration to control the activities of US commercial banks could intensify the fall in markets, not just in China but globally. A sharply falling stock market in China will have the impact of taking a lot of speculative money out of the system; business and consumer confidence will weaken; the economy will grow more slowly; and funds will be taken out of metal markets. For most of 2010, we should see stock and metal market prices falling.

We wouldn’t want to say it can’t happen. Simon Hunt has been through several recessions before and is one of the most experienced metals analysts in the market. We feel the projection is excessively gloomy and once the Chinese New Year is out the way the markets will recover from their current nervousness, but much will depend on the actions of administrators in Washington and Beijing over the next 3-4 months, and how driven to act they feel by the economic data being released.

–Stuart Burns

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