The two meetings

Besides the ongoing troubles in the eurozone, the other burning issue for investors is, of course, what will emerge from the just-concluded ‘Two Meetings’ in China where the new team of Li Keqiang and Xi Jinping have formally taken up the reins.

Before we make any comments on what has transpired, we must offer the essential caution that all we have so far are words carefully calculated to strike the right notes with an expectant mass audience. To what extent these reflect a genuine intent and what degree of consensus within the Party any such intent might command is entirely unknown and may well remain so at least until after the autumn Plenum of the Party Congress.

With those qualifications attached, what we can gather from the coverage so far presented is that, by their own admission, the incoming leaders know they face major problems of over-capacity in all manner of key industries—solar, aluminium, steel, etc.—and yet we also know that, despite this week’s ground-breaking bankruptcy of Suntech—old habits die hard when it comes to desisting from propping these industries up. Witness the announcement last week that the State Reserves Bureau would buy one-sixth of the nation’s aluminium and one-eighth of its zinc output this year— a bailout of an ailing sector, however you consider it. Nor does it bode well that steelmakers are pouring record amounts of the alloy a few brief months after many of them were facing ruin (aggregate profits fell a mere 98% last year) and despite a 20% YTD rise in the stocks of cold-rolled coil, a 40% rise in hot-rolled, and 90% rise in those of rebar.

By their own admission, too, the problem of chronic property speculation remains a bugbear and while the optimistic may be happy to wait for the accelerated urbanisation programme (about which no details have, of course, been vouchsafed) to absorb any vacant buildings, they have not yet quite managed to explain how it is that people whose average urban wage is some CNY 40,000 a year will afford all those CNY 20,000/sq m properties currently changing hands in the main urban centres. One means to achieve this financial marvel may well be through the notorious rehypothecated copper dodge (Asian stocks of the metal are up 90% so far in 2013 from the previous three year average) and via mis-invoiced export earnings (q.v., the $25 billion YTD discrepancy between China’s reported exports to HK and the latter’s reported , one-third lower imports therefrom). ‘Reform’ will have to find a way either to close this loophole or make it far less lucrative.

Urbanization may also have a few other hurdles to overcome if we heed the CASS-NDRC joint report on how Beijing’s 20 million inhabitants have already overstrained the land and water resources available to them. More to the point, the authorities have yet to admit that while they keep money and credit growth powering along in the 10s and 20s of percent a year and simultaneously set interest rates at or below the consequent rise in the cost of living, people will naturally look to the property market as a more secure outlet for their surplus cash, whether or not they also hope to get rich quick along the way.

By their own admission, too, fears of financial fragility are rising, as speculation mounts about a coming crackdown on both the notorious LGFVs and the regulation end-running WMPs into which many of these are subsequently bundled. The fact that the new CSRC chairman will be none other than former BOC boss Xiao Gang—the man who dubbed such products ‘Ponzi schemes’ in a recent tirade—might add substance to these rumours.

All this comes at a time when, as our friend Jim Walker at Asianomics pointed out, a report published under the twin auspices of the China Association of Trade in Services and the Chinese Academy of International Trade and Economic Cooperation estimated that the total of accounts receivable on company balance sheets amounts to a vertiginous CNY22 trillion—almost 40% of GDP and pretty much on a par with that extant the much larger United States. If correct, we should compare the 18% reported increase in this book credit (an increment of CNY3.4 trillion) with ’above-scale’ industry reported profits (not an exactly overlapping sample) of around CNY5.5 trillion. Staggering, indeed.

By their own more tacit admission, the authorities are all too aware that they have a problem on their hands with the growing public ire at the polluted state of the environment—a disquiet we could actually read as a sign of substantial material progress having been made, since such concerns are often too much of a luxury for a poor people, too busy scrambling to fill their children’s bellies to fret about the ambient air quality. 

For all the anecdotal horror at which we love to gawp, it does not do to be too superior about this. Just 60 years ago, the Great Smog which enveloped London for four cold, December days may have rendered 100,000 ill while contributing to the demise of up to 12,000 afflicted souls. Nor would any of us much care to stroll along the ordure-strewn thoroughfare of a Victorian city, much less eat the food or drink the water on offer there. Yet this, too, was a time of rapid material advance when wealth was being created across the social spectrum, at a hitherto unprecedented rate.

Nevertheless, China’s lack of accountable governance, its absence of private property rights, and its fetish for output regardless of many internal costs, much less external ones, makes this a difficult matter to address. Pampered metropolitan Lefties may bewail the role of capitalism in scarring the face of holy mother Gaia, but for a REAL disregard of one’s surroundings or one’s posterity, you have always had to look to the Collectivists to take the palm in the scorched earth stakes.

As well as extending the rule of law, the state needs to stop subsidizing heavy industry and making power and fuel artificially cheap while, conversely, it needs to insist upon proper waste disposal and to levy (or allow the market to levy, in an ideal world) a proper charge for rendering that detritus harmless.  If the Chinese people now want cleaner surroundings, this is what they must demand of their leaders and, by extension, of themselves, but it will not come without some sizeable short– to medium-term sacrifices in growth-for-growth’s sake and therefore in employment. The effect on costs and profitability may be a harder prospect to judge since the bill for some inputs (and for the treatment of many unwanted outputs) will no doubt rise, but the overall call on resources could likewise end up being reduced as efficiencies are incentivised and mindless capacity overlaps eradicated. Along with that fall in demand, the price paid for this lesser but better-utilised quota should move in tandem.

How much if any of this we get is a matter of no little doubt, as we said at the beginning of this article, but the local press is foursquare behind the idea that the new team represents at once a radical change and a reversion to the better management of the system which, so the accepted wisdom holds, was the norm under the aegis of Zhu Rongji—several of whose protégés are to be found in the refreshed line up of officials.

Caixin, for one, had this to say:-

Contrary to the expectations of many investors, policymakers have decided not to seek any big increases in government investment this year. Rather, they want to prevent any possible financial trouble tied to local government debt and the off-balance-sheet operations of commercial banks. That means regulations covering local government financing platforms are likely to be tightened… Also highlighted in the government policy book are plans to seek quality over quantity in economic growth, adjust real estate and business tax structures, control housing prices, and reign in fiscal spending.

Or, as more pithily expressed to Reuters by an anonymous visitor to the National People’s Congress:-

Delegates… were clearly agreed that their biggest risk was doing nothing.

But let’s not rest there. Look at the following extracts from new Premier Li Keqiang’s headline, after-party press conference and judge for yourself which way the wind is blowing:-

Reforming is about curbing government power, it is a self-imposed revolution, it will require real sacrifice, and this will be painful, but this is what is wanted by the Government and demanded by the people.”

“We need to build a clean government and make our government more credible … The important thing is action—talking the talk is not as good as walking the walk.”

“The highest priority will be to maintain sustainable economic growth.” [emphasis ours]

“We said that in pursing reform we now have to navigate uncharted waters. We may also have to confront some protracted problems. This is because we will have to shake up vested interests… Sometimes stirring vested interests may be more difficult than stirring the soul, but however deep the water may be, we will wade into the water. This is because we have no alternative. Reform concerns the destiny of our country and the future of our nation.”

As he proclaimed at the end of last year:-

Reform is like rowing upstream. Failing to advance means falling back. Those who refuse to reform may not make mistakes, but they will be blamed for not assuming their historical responsibility.

The old saying has it that ‘fine words butter no parsnips’ and there are few less root vegetable-greasing words than those which emanate from a politician’s mouth, but, in light of all the foregoing, it does very much seem as if the CCP regards the present juncture as an existential moment in its 90-odd year history.

Having raised expectations so high and having the luxury of a honeymoon period in their relationship with their long-suffering subjects in which to enact any radical changes, we must assume that the leadership would be very unwise to slip back into business-as-usual anytime soon and so disappoint the hopes of so many.

To what extent reform will be attempted—and how much resolve will be shown when, as is highly likely, the effects of those reforms expose the many interdependent flaws and critical fractures in the system—only time will tell but, one way or another, it is hard to resist the impression that those in China—and, by extension, those of us who make our living trying to account for that nation’s effects on the wider world—are truly about to ’live in interesting times’

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