The silver lining in Chinese Inflation

China has increased its Reserve Ratio Requirement (RRR, the amount required to be set aside by the banks, not to be used for lending) yet again...by 0.5% to mop up an additional USD 54 bn from the market with an intention to reduce liquidity and control inflation. Let's take a quick look at the different problems confronting China:

The Liquidity Problem:

Consider this, Chinese banks lent around USD 1.6 trillion (almost equal to India's GDP) in 2010, most of it for infrastructure, and lent almost around USD 160 bn in January alone (!), a figure that's almost twice that of December 2010.

The Inflation Problem:

Inflation in China is already quoting around 5%, according to official figures. I've covered Chinese Inflation issue in my earlier posts, consider reading Betting on China Crash and Understanding China and Japan. Also, while food prices are under control for now, the housing market continues to hog limelight. House prices rose in Jan 2011 in 68 out of 70 Chinese cities surveyed. This, despite the introduction of property tax (though a measly 0.6% to 0.8%) and frequent increases in RRR.

The Currency Problem:

China has been under pressure from various international organizations with sovereign members to let its currency appreciate. Currency appreciation will make its exports less competitive though it might play some part in checking inflation. Currency depreciation will boost its economy but increase the inflation problem. So China has constantly let its currency appreciate, and shows this as compliance to currency non-manipulation to better manage international relations. See the USD Yuan chart below which shows how yuan has appreciated against dollar:

Though the appreciation is there, but its too less, too slow...over the last 1 year, yuan has appreciated by about 4% against dollar.

Soft landing measures:

On the face of it, it looks like Chinese measures are failing to keep both inflation and real estate bubble in check. But just think about it, how difficult would it really be for the Chinese government to dictate terms and functioning to Chinese Banks if they really wanted to curb lending to infrastructure? And please bear in mind, Chinese Banking industry is considered by many investors as fairly opaque and government driven...(part of the reason why Chinese banks don't openly participate (except through proxies) during sale / purchases of various sovereign debt instruments). 

China cannot afford to have a real estate bubble crash now...and they know it pretty well. The introduction of property tax also reeks of a gesture to please foreign investors more than anything else. They're completely abstaining from increasing interest rates to avoid a "Yuan Carry trade" situation (read more about this here) which will further worsen the inflation problem. In essence, all efforts are being made to not shake-up the real estate bubble, which has long assumed the position of "too big to fail".

So liquidity control without raising interest rates is probably the best way they've got. And this they're doing not just by increasing the RRR, but even, to a smaller extent, by acquiring Gold mines outside and simultaneously promoting consumption / investment in Gold / Silver in China. So people are just converting their yuan into Gold / Silver, which eventually will go to the owner of these mines from where the metals are being procured...the Chinese government held companies. [This, by the way, is also helping them control inflation through currency appreciation - as yuan supply reduces, it appreciates against its basket of currencies.]

In fact, so strong has the demand been off late, that even China's appetite for Gold and Silver is making frequent headlines. Here's an article from Zero Hedge giving various news items (most of them recent). The result...take a look at the silver prices:

Now, if this is indeed the case, and encouraging gold and silver consumption domestically is indeed a strategy adopted by the Chinese government, it's only a matter of time before both break their all time high and surge further ahead...Now, that's a silver lining in a dark inflationary cloud...

Random Walk - Econo blogging

Apologies for not writing for such a long time...guess I've been hit by the Writer's Block. Nevertheless, this post is about econo-blogging...and about how some digging into it almost took the steam off my writing...

Came across this website econdirectory through Mish's site. The website gives a huge list of all the blogs which write on economy (and does not include those which restrict to just plain and simple stock tips). It covers some 165 websites, most of which have public page views, and some others which don't. Overall, the top 5 guys in the list take up the major portion of readership...here's a sample of what it looks like...

A massive 61% of all page views are with the top 5 blogs, and a good 54% with just top 4. The rest of the 160 blogs consist of the remaining 39% page views. The page view by the latter segment is small enough for each one to not sustain any meaningful ad revenues. 

The NY Times even listed DIY (Do It Yourself) Macroeconomics as one of the top trends of 2010...in which, says NY Times "ordinary citizens pull apart the data and come to their own conclusions". So while more and more econo bloggers are joining the band-wagon, the pie is not undergoing any major expansions, resulting in traffic being held as captive audience by the top few websites.

Its tough getting into the top 20 list, and like even Mish pointed out, that would, under current circumstances, result in having just 5% of the traffic of the top blog...! But just like they say for Euro zone, there's hope...things could've been worse...

Golden movements

Gold has been falling for quite some time now...giving rise to talks about whether it has seen its peak for some time to come...take a quick look at the 30-day Gold Price chart below:

This fall came in the backdrop of US showing signs of recovery, quoting better unemployment  numbers and good consumption increases. This led to people moving out of emerging markets plagued with unsustainable inflation and prospects of lower growth and overall shrinking corporate margins; just as investors moved out of gold as well. People were again backing  dollar denominated assets, US and European markets. Take a look at how US and European markets have performed over the last 1 month.

But still, its not that investors have started looking at dollar any more appreciatively...the US Dollar Index, which shows the strength of dollar against various currencies, continued its downward journey over the last 1 month.

All this points towards some sort of portfolio reallocation among some major funds of the world. As a part of their strategy, they are taking some profits off the table from Gold, liquidating their positions in emerging markets, and increasing the weight of US and European stocks in their overall portfolio.

However, to me, Gold still looks like a minor correction before the rally resumes...nothing more. Egypt is on the boil due to political unrest, creating tensions in almost whole of middle east...which is spooking the investors worldwide. Once that settles down, Europe will come right back on the radar. And then may be Japan, who knows; with 200% of GDP as debt, 1 in every 4 persons above the age of 65 and no longer contributing to the savings (which was being used by government to raise debt), Japanese government will sure have to look for other avenues to raise debt just to keep paying off its interest on the debt..leave alone retiring the debt. China's real estate bubble can now be seen from outer space (;)), and once that crashes, it'll take a whole lot of other asset classes with it, right from Copper and Soybeans to Equities and Bond prices. Asia, just because of these two big shaky giants...is a risky place to invest.

But fundamentals for Gold still look intact. Central banks are still buying Gold...and these are the biggest players in the market - please bear in mind, they don't get in into the market to make a quick buck and move out as soon as profit targets are achieved...they're in for long.

Take a look at this article here, that talks about how Russia added 135 tons of Gold in 2010...an increase of almost 21% from their 2009 end Gold holdings ! Saudi Arabia has disclosed a purchase of 180 tons which has come in due to "adjustment of gold accounts". Take a look at the latest Official Gold Holdings for countries:

World_Official_Gold_Holdings_January_2011

Getting back to brass tacks, it means that US has almost USD 350 bn of Gold with it. Germany has nearly USD 147 bn, Italy and France has USD 105 bn each, China has USD 45.5 bn worth of Gold, while Russia and Japan have 33 bn dollars worth of Gold each and India has around 24 bn dollars worth of Gold.

The Gold reserves of US, though the largest in the world, are still far away from its Debt levels of USD 9 trillion (not accounting for contingent liabilities - like medicaid and Social security). Germany, France and Italy will need these reserves to boost world confidence in their ability to come out of this crisis...any selling by these central bankers in time of crisis might trigger a sharp fall in Gold prices which will further depress the reserves status of almost all nations with substantial Gold holdings - and so is fairly unlikely to happen. 

China has a long way to go  as far as diversification in gold is concerned since its gold reserves are just 1.8% of its nearly USD 2.5 trillion reserves. This thought has also been propounded recently by Xia Bin - adviser to China's central bank (see here).

The world is still quite close the uncertainty in several aspects...China's hunger for Gold will not go down, central banks will not sell their gold in a mad rush...these, and many such aspects are bullish signs for Gold...so for me, its still a good buy on all dips.

Addendum: See this article from Financial Times that talks about some gold traders estimating that China has probably bought around 200 tonnes of Gold in the last 1 month ! That's nearly 36% of India's Total Gold reserves ! Let's wait for China to release data on Gold reserves again...and we'll know how true these estimates were...

Betting on China Crash

The rumblings of an imminent Chinese crash are getting louder by the day...giving an eerie feeling that something too big is so close that we're not able to see it!

Consider this article in Telegraph a couple of weeks back, which says how many hedge funds are now betting that China would crash sometime soon. It says:

"One academic said: “Economists have contrarian views all the time. But these hedge funds have their shirts on the line and do their analysis carefully. The flurry of 'distress China’ funds is a sign to sit up.” ...A recent study by Fitch concluded that if China’s growth falls to 5pc this year rather than the expected 10pc, global commodity prices would plunge by as much as 20pc."

This is understandably so, given the huge amount of fears from Inflation, asset bubbles (especially real estate) and uncontrolled lending spree by the banks. Its not as if China is not aware of these issues...or not working on them. It has been tightening its bank's reserve ratios to absorb excess liquidity available with the banks. It has been buying European Union's debt to prop up Euro against the dollar and also yuan (Chinese currency). Keeping yuan lower with respect to Euro will help China in boosting their exports to Europe and give them some breathing space in terms of trade deficit (Exports - Imports).

The article further says:

"According to Corriente (Advisors), China has consumed just 65pc of the cement it has produced in five years, after exports. The country is outputting more steel than the world’s next seven largest producers combined. It has 200m tons of excess capacity. In property, Corriente said it had found an excess of 3.3bn square meters of floor space in China – yet 200m square meters of new space is being constructed each year."

Besides, Chinese real estate bubble is fairly well documented...an average apartment in Shanghai costs more than 22 times of disposable income there...making it beyond reach for most people. HK was recently reported as the costliest city in the world for housing. Despite several efforts to curb speculations on housing, China has been able to achieve little by way of increases in reserve ratios. However, recently it has put up a property tax for the first time...(read here). But with the rate at about 0.6%, it looks like a case of too little too late.

Take a look at another recent article in Telegraph that talks about how the real estate bubble could be growing bigger in China. The article mentions:

"The property tax would have "a big psychological effect on potential home buyers," said Ge Haifeng, head of research at China Real Estate Index System in Beijing. "China's housing market may get really quiet in coming months," he said. "

Big Impact !! A 0.6% property tax rate? In India, retail investors pay that much as brokerage (each leg) for all equity transactions ! Does that kind of rate stop them from trading? I don't think so...In India, property tax rates are fairly high and vary from state to state...and to me, a 10% + service tax (of 2%) is a normal rate for property taxes....that's how much people pay in India as their property tax...8-15% of property value...and it still does not stop people from speculating. And many Chinese, who are traditionally gamble-happy people, are expected to stop speculating the housing market because of a 0.6% property tax ! Let's just say, this is being made up to send a message to the markets that a lot is being done to keep bubbles in control...but obviously, the markets are not impressed.

I think this is more likely a warning signal to speculators to move out of the market and not get caught with their open positions when the rates are increased. The idea in such a case would probably be to remove the panic from the market when property rates are raised further, and thus ensure that a crash in real estate prices would not happen. But how it actually unfolds, only time will tell.

Chinese Automakers are also facing tough times with restrictions on selling cars being put up in most populous Chinese cities to reduce traffic jams. It'll again have a cascading effect as the automobile ancillary units are also an industry in themselves and will suffer major losses due to loss of revenue.

Also, with China talking of "no need for yuan to appreciate" since exports will slow down in 2011, it looks like even the pretense of letting yuan come up over a period of time is over now. This is not going to help the geo-political equations, look forward to comments from the US.

Even the credit default swaps (CDS) rates - the instruments through which people bet for a sovereign nation defaulting on payment of its debt, have been increasing for China...it means that more and more people are buying these instruments at ever higher prices, in the belief that when Chinese economy really looks weak, or even tumbles, they'll make a handsome gain on these investments. I have a rather dated article mentioning this, take a look at that here.

Will China really go bust? Its difficult to predict, given the fact that we don't even know that the numbers that we're talking about are true or not (these are, and can be massaged by government agencies). China's public debt is reportedly just about 20% of its GDP compared with 40% for India, 60% of US and nearly 200% for Japan. It can no doubt continue to build bridges to nowhere for some more time, and hoard gold to protect itself from a dollar bust scenario, but eventually, all this lending spree and housing bubbles have gotta give...and they will. But when? Now, that's a trillion dollar question!