This week has seen some wild movements in the Chinese interbank unsecured lending market, which is benchmarked by the Shanghai equivalent of the familiar Libor rates, called the Shibor, and its equivalent in the repo market. Given how tightly controlled Chinese capital markets are, and the authoritarian powers of the government over private and public firms, it is a bit strange to see this kind of fluctuations, but the market barely took note, perhaps because not many people are following these statistics, and fewer yet are concerned. It is difficult to say that the recent tension will transform into something more significant, because the government could at any moment relax controls to avoid complications. But there is a threshold, to be sure, beyond which the damage wrought by the such turmoil is inelastic in the sense that what is lost cannot be replaced. We will be focusing on China, as usual, to see what exactly the developments mean.
The Financial Times is attributing the cash squeeze to an apparent scrambling for cash by SOEs and banks that lend to them in anticipation of aggressive tightening by the PBOC which will reduce the available lending channels significantly, and, we suspect, lead to a sharp reversal in real estate prices that are widely believed to be in the wild stages of a bubble. The Financial Times quotes, "For instance, HSBC remind that the property bubble is in large part a joint creation of local governments’ use of land sales for revenue (about 60 per cent of total revenue for Beijing, Shanghai and Tianjin in 2009), plus the wild over-bidding by SOEs ..."
Much of the rest of the world, from Mexico, to Indonesia, to Turkey are well-informed about the kind of distortions and disinformation that can be created by the activities of SOEs the excesses of which have been the root cause of many crises and even defaults in the EM world during the 1980-2000 period. The Chinese, being the Communists that they are, have little option in maintaining some of these lumbering corporations in order to prevent rapid rise of the unemployment rate. And perhaps more importantly, the massive cash influx into the country easily allows any kind of sub-optimally performing enterprise to survive and prosper by various kinds of speculative activities, and investments that findgood returns, bolstered by the fiscal, and FX distortions engineered by the government. Clearly, such cash recycling that allows potentially loss-making SOEs and cash-tight local governments to prosper is one of the main reasons that the asset markets of the country are almost completely out of touch with reality.
The surprise rate rise on Christmas Day, and the hints, and the general understanding among analysts that the Chinese will continue to tighten considerably into perhaps the second half of the year, has apparently led to a rapid realignment among many of the drivers of the real estate bubble. It is well-known that crises and market crashes tend to follow aggressive rate movements by central banks, and it is possible to conceive that something of the sort will happen this time, as the bloated Chinese real estate sector implodes on itself creating economic chaos in the country. But we believe that it will not be the Chinese government, but the natural processes of the market, probably bolstered by strong protectionist measures around the world that finally deflate the bubble, because the government has always been extremely cautious about tightening and reining in speculation, even in the most uncontrollable stages of the Chinese stock market bubble which, incidentally, only collapsed in November 2007 through precisely such reasons. So while the movements in Chinese markets are meaningful, it is too early to reach strong conclusions about their significance.
In other events, the market focus is found to be on the NFP release tomorrow, after the ADP numbers of Wednesday set up expectations for a rather bullish number. We suspect that the past months may see some upward revisions, but we are skeptical about the significance of the ADP release, since the correlation between NFP and the ADP data has been rather week over the past years. In any case, some positive adjustment in the unemployment rate would be neither surprising nor very significant, given the size and scope of the Fed`s efforts, and the stagnant state of the labor market over years now. Similar to the case of the occasionally robust numbers from the real estate sector, it is unclear that any short-term strength in this field can have a long-term significance in the absence of fundamental readjustments in consumer mentality, U.S. and Asian bilateral relationship, growth models, and a devaluation of the dollar. We believe that the turnaround will only come once the American economy is firmly on the track to reverse course and explore alternative development strategies, with a smaller more compact finance sector, a larger manufacturing industry, a shrinking external deficit, and some steps towards reducing the public debt burden. As long as these issues remain, it is very difficult to project a permanent healing of the consumer psychology.
Today equities are mixed, the USD is higher against most currencies, but lower against the JPY, while gold is mostly unchanged, consolidating after the 3% fall early this week. Markets are awaiting the NFP numbers, and today`s main theme of discussion is the disappointing retail sales numbers from the winter season. On the whole, it is a reasonably quiet day, and perhaps the weakness in some markets is a consequence of the uneasiness before the payrolls release.
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