China’s export dilemna

Growth in value of exports from China has slowed to single figures since 2012. It will be difficult sustain current GDP growth if this trend continues.

China Exports

The Harper Petersen index of shipping rates for container vessels, the Harpex, remains near its 2010 low, reflecting continued weakness in Asian manufactured goods exports (a rise in exports from Europe or North America would be absorbed by the high percentage of containers returned empty to Asia on the round trip).

US Imports from China

Rising Australian bulk commodity exports reflect the disconnect between Chinese imports and exports, with vast investment in infrastructure and rising stockpiles of raw materials used to sustain economic growth. But diminishing marginal returns on further infrastructure and housing investment mean failed recovery of manufactured goods exports would lead to a hard landing.

Australian Bulk Commodity Exports

A key factor will be the strength of the RMB against the US Dollar. Ambrose Evans-Pritchard suggests that China will meet strong resistance in its attempts to export its deflation to the West. Treasury’s forex report to Congress (April 2014) highlight’s sensitivity toward further exchange rate manipulation:

In China, the RMB appreciated during 2013 on a trade-weighted basis, but not as fast or by as much as is needed, and large-scale intervention resumed. The RMB appreciated by 2.9 percent
against the dollar in 2013. However, as a result of the depreciation of the yen and many emerging market currencies, the RMB strengthened more on a trade-weighted basis, with the RMB’s nominal and real effective exchange rates rising 7.2 and 7.9 percent, respectively. For most of 2013 the RMB exchange rate was at, or very near, the most appreciated edge of the daily trading band, suggesting continuous pressure for greater RMB appreciation. During 2014, however, the exchange rate has reversed direction, depreciating by a marked 2.68 percent year to date.

There are a number of continuing signs that the exchange rate adjustment process remains incomplete and the currency has further to appreciate before reaching its equilibrium value. China continues to generate large current account surpluses and attracts large net inflows of foreign direct investment; China’s current account surplus plus inward foreign direct investment in 2013 exceeded $446 billion. The reduction in the current account surplus as a share of China’s GDP has largely been the reflection of the unsustainably rapid pace of investment growth. Finally, China has continued to see rapid productivity growth, which suggests that continuing appreciation is necessary over time to prevent the exchange rate from becoming more undervalued. All of these factors indicate a RMB exchange rate that remains significantly undervalued. Further exchange rate appreciation would help to smoothly rebalance the Chinese economy away from investment toward consumption.

The Chinese authorities have been unwilling to allow an appreciation large enough to bring the currency to market equilibrium, opting instead for a gradual adjustment which has now been partially reversed . The expectation that the RMB would continue to appreciate over time resulted in large and increasing capital inflows in 2013. The PBOC’s policy of gradual adjustment triggered expectations of continued appreciation, and resulted in large-scale foreign exchange intervention. China’s foreign exchange reserves increased sharply in 2013, by $509.7 billion, which was a record for a single year. China has continued large-scale purchases of foreign exchange in the first quarter of this year, despite having accumulated $3.8 trillion in reserves, which are excessive by any measure. This suggests continued actions to impede market determination.

In short, China has been buying US Treasurys as a form of vendor financing, allowing them to export to the US while preventing the RMB from appreciating to its natural, market-clearing level against the Dollar. The fact that they are attempting to disguise this manipulation, using third parties, means that Congress is unlikely to tolerate further suppression of the RMB against the Dollar and will be forced to take action.

Feared sales of US Treasury investments by China, leading to a collapse of the Dollar, are most unlikely and would be a death knell for Chinese exports. Reversal of capital flows would cause rapid appreciation of the RMB against the Dollar, up-ending China’s former competitive advantage and boosting US exports.

Even without a reduction of existing Treasury holdings, appreciation of the RMB against the Dollar and Euro appears inevitable. This would be disastrous for China, causing them to forfeit their competitive advantage in export markets. And without access to the level of technology and global branding enjoyed by their Western counterparts, Chinese exporters are likely to struggle to hold existing markets, let alone achieve further growth. With diminishing returns on infrastructure and housing investment, China could soon run out of options to stimulate its economy. And its path as a global economic powerhouse may well follow that of its predecessor, Japan.

What Ukraine Crisis Means for Future of Europe | SPIEGEL ONLINE

Interesting extract from Spiegel interview with Prof. Timothy Snyder from Yale:

SPIEGEL: What motivates Putin?

Snyder: I think Putin is playing an all-or-nothing game, geopolitically speaking. He no longer cares about tolerable relations with the EU or about a solid relationship with Ukraine. Putin has opted for something else, a much larger project, to destabilize Ukraine and the EU. It’s an all-or-nothing game because there is no going back, now that he has embarked on this path.

SPIEGEL: Can he win?

Snyder: There are two options now: Either he achieves his goals, or the European Union achieves political unity and ideological stringency. It would have to define itself as Russia’s adversary and, most of all, develop a joint energy policy with which it could affect Putin. If the EU could do that, there would be radical consequences for Russia. Then Putin would have to fall back on China, and Russia would become China’s Ukraine.

via Experts Discuss What Ukraine Crisis Means for Future of Europe – SPIEGEL ONLINE.

Ukraine crisis offers lessons in how to handle China’s ambitions

Chilling analysis by Simon Leitch of the use of force by Russia and China to achieve political objectives:

Because China and Russia are major powers with nuclear weapons, dangerous conventional forces and economic leverage, states seeking to deter them from territorial challenges lack credible threats. To address this they must learn the Cold War lessons of manipulating risk or forfeit the initiative to opponents.

This is a high-stakes game of chicken which could encourage smaller states to pursue their own nuclear deterrent and indulge in aggressive, irrational, North-Korean-style behavior in order to discourage aggression from their larger neighbors.

Read more at Ukraine crisis offers lessons in how to handle China's ambitions.

Is the market overpriced? Episode V

In my last post I concluded that the same factors driving rising inequality — new technologies and access to cheap labor through increased globalization — may also be driving a sustainable increase in corporate profits. While we may be understandably wary of “this time is different”, consider the following:

The rise of China as a trading partner over the last two decades.

US Imports from China

Corporate profits at 11% of GNP suggest a new paradigm when compared to the historic (normal) range of 5% to 7%.

Corporate Profits/GNP

The decline in employee compensation as a percentage of corporate value added mirrors the rise in corporate profits.

Employee Compensation/Value Added

And Robert Shiller’s CAPE, normally used to argue that the market is currently overpriced. If we stood in 1994 and looked at the range of CAPE values for the past century, we would no doubt have concluded that a CAPE value greater than 20 indicates the market is overpriced. In the last two decades, the CAPE only briefly dipped below 20 at the height of the global financial crisis. Now pundits argue that a CAPE value greater than 25 indicates the market is overpriced. Something has definitely changed.

Shiller CAPE

Whether the change is sustainable, only time will tell. But one thing is clear. Of the 466 corporations who have so far reported earnings for the first quarter 2014, 77% have either beaten (68%) or met (9%) their estimates. Corporate profits are not in imminent danger of collapse.

Is the market over-priced?

In my last post I concluded that the same factors driving rising inequality — new technologies and access to cheap labor through increased globalization — may also be driving a sustainable increase in corporate profits. While we may be understandably wary of “this time is different”, consider the following:

The rise of China as a trading partner over the last two decades.

US Imports from China

Corporate profits at 11% of GNP suggest a new paradigm when compared to the historic (normal) range of 5% to 7%.

Corporate Profits/GNP

The decline in employee compensation as a percentage of corporate value added mirrors the rise in corporate profits.

Employee Compensation/Value Added

And Robert Shiller’s CAPE, normally used to argue that the market is currently overpriced. If we stood in 1994 and looked at the range of CAPE values for the past century, we would no doubt have concluded that a CAPE value greater than 20 indicates the market is overpriced. In the last two decades, the CAPE only briefly dipped below 20 at the height of the global financial crisis. Now pundits argue that a CAPE value greater than 25 indicates the market is overpriced. Something has definitely changed.

Shiller CAPE

Whether the change is sustainable, only time will tell. But one thing is clear. Of the 466 corporations who have so far reported earnings for the first quarter 2014, 77% have either beaten (68%) or met (9%) their estimates. Corporate profits are not in imminent danger of collapse.

Dr Copper: China weakening

Falling copper prices reflect a weakening Chinese economy. Follow-through below $6600/tonne, after breaching primary support at $6800, signals a primary down-trend.

Copper

China will never support Putin on Crimea

Offering the people of Crimea a referendum — on whether to secede from Ukraine and join the Russian Federation — may appeal to Vladimir Putin but he should not expect support from China. For two very simple reasons: Hong Kong and Taiwan. China claims these two territories as part of China, but there are no prizes for guessing the outcome if a similar referendum (to secede) were held in either territory.

Putin’s ploy

The Wall Street Journal quotes Vladimir Putin’s justification for occupying the Crimea:

Russian President Vladimir Putin said Tuesday that Russia reserves the right to use force in Ukraine to protect Russian-speaking residents there…….”

This was a ploy used by Hitler to assert control of the Sudetenland in 1938. Sudetenland is the name given to the border districts of Bohemia, Moravia, and parts of Silesia, within Czechoslovakia, that had large German-speaking populations. Hitler encouraged Konrad Henlein, leader of the Sudeten Nazis, to rebel, demanding a union with Germany. When the Czech government declared martial law, Hitler threatened war. This led to the September 1938 betrayal of Czechoslovakia by France and Britain. Adopting a policy of appeasement, the two countries agreed to give Hitler the Sudetenland, with Chamberlain describing the crisis as “a quarrel in a faraway country, between people of whom we know nothing”. On his return to London, Chamberlain asserted that the accord with Germany signaled “peace for our time”.

Hitler enters the Sudetenland, October 1938

Hitler enters the Sudetenland, Bundesarchiv, Bild | October 1938

In March 1939, German troops occupied the rest of Czechoslovakia. In September 1939, Hitler invaded Poland on a similar pretext of protecting the German minority from persecution. War followed, leaving more than 60 million dead. Almost two-thirds were civilians.

Hopefully Western leaders have learned from history. Appeasement is not an option.

Read more at BBC History and Wikipedia: The Sudeten Crisis.

An appeaser is one who feeds a crocodile, hoping it will eat him last. ~ Winston Churchill

China Sides With Russia on Ukraine | The Diplomat

Shannon Tiezzi writes:

China’s ambiguous position reveals its dilemma. Beijing’s instinct is to back Moscow, both to uphold the fruitful cooperation between these two nations and to stand firm against pressure from the West. However, vocally supporting Russia would violate China’s principle of non-interference. More importantly, it could arguably set a precedent of Chinese support for military intervention to protect separatists unhappy with their government—which goes against all China’s instincts, given its own issues with Tibet and Xinjiang provinces. Yet as the Global Times put it, at the end of the day power calculations mean more than principles. China’s geopolitical strategy requires Beijing to at least tacitly support Russia, and at the end of the day that argument outweighs more abstract philosophical concerns.

Read more at China Backs Russia on Ukraine | The Diplomat.

As China looks on, Putin poses risky dilemma for the West | Reuters

David Rohde at Reuters quotes James Jeffrey, a retired career U.S. diplomat:

Jeffrey said the days and months ahead will be vital. If Putin faces few long-term consequences for seizing Crimea, it will set a precedent for China and other regional powers who may be considering establishing 19th century-style spheres of influence of their own.

“The Chinese,” Jeffrey said, “are in the same position.”

Read more at As China looks on, Putin poses risky dilemma for the West | Reuters.