March 20th, 2014
Investing Daily Article of the Week
by Philip Springer, Investing Daily
After hitting new Friday March 07, US stocks slumped last week, primarily because of concerns about China’s economy and rising tensions in Ukraine.
For world markets, China was the bigger issue. Two weeks ago, China announced an economic growth target of 7.5 percent for 2014. That’s robust by almost any standard, except compared with the 9-10 percent rates of 2009-12. And it would be the slowest growth since China’s growth took off in 1991.
Growth slumped to 7.8 percent in 2013, and even 7.5 percent may be hard to achieve in 2014. China Premier Li Keqiang this week said that the world’s second-largest economy faces “more difficulties” this year than last.
Industrial output, retail sales and investment all grew considerably less in January and February than expected, according to government reports released this week. Also in February, China’s exports tumbled 18.1 percent, and the country posted an unusual trade deficit of $23 billion. Economists had expected a 5 percent increase, following a 10.6 percent expansion in January.
There’s always the question of how much the February data was distorted by reduced manufacturing activity due to the week-long Lunar New Year holiday. (This is the Year of the Horse.) And there’s always reason to question Beijing’s economic numbers. The lack of transparency in China’s financial policies also often generates investor uncertainty and anxiety.
But the signs of weakness in China’s economy clearly are growing. So far, the damage to the rest of the world has been limited mostly to some commodities and other Asian markets, in addition to China’s own stock market and currency.
However, further China weakness could add to the volatility of emerging markets overall that has increased sharply in recent months. And it could hurt developed markets, as happened this week.
In 2013, China accounted for about two-thirds of global demand for iron ore. Its spot price has dropped 22 percent so far this year to the lowest point since October 2012. Copper is down 13 percent, to its lowest level since August 2010. China accounted for an estimated 44 percent of demand for the red metal last year. The price of premium hard coking coal from Australia, another China-driven commodity, also has dropped 13 percent this year.
For copper in particular, the damage isn’t limited to the inventory buildup in warehouses in China as demand for manufacturing slows. In addition, much of the stored copper is used as collateral for loans from banks, and particularly from other lenders in borrowers’ response to government restrictions on conventional lending.
Borrowers then invest the money in higher-yielding assets. As prices fall, borrowers could come under pressure to post more collateral, forcing them to sell copper to raise money.
However, there’s also considerable evidence that the government has enacted a deliberate slowdown to expand market forces, wring out some excesses in the economy and put it on a firmer footing for lower but more sustainable growth.
For example, China last week had its first mainland corporate-bond default (a solar technology company). It had been widely believed that the Chinese government was in effect guaranteeing this part of the country’s credit market.
Beijing also has moved to push down China’s currency, the yuan. This is seen as a way to reduce excessive “hot money” inflows from foreign speculators/investors.
Within China, the tightly controlled currency is allowed to trade within a range of 1 percent above and 1 percent below a daily reference rate fixed by the central bank. The government has been letting the rate climb, which means a weaker yuan. The offshore yuan, which is freely traded outside mainland China, this week dropped to an eight-month low versus the US dollar.
The declining yuan also makes it more expensive to import dollar-denominated commodities, including the copper used as loan collateral.
For many observers, the big debate now is whether the Chinese government will step in if growth slows much more. For example, with the new leadership’s agenda in place and a series of key annual party meetings completed, the way may be clear for the government to act if it chooses to.
In any event, China generally has proven relatively adept at guiding the nation’s economy, and it has plenty of financial resources at its disposal to do so.