Events Friday appeared to be dominated by the release of Q3 Chinese GDP data, which came at 9.8, above the expectation of 9.4-9.6 current in the market. Inflation is reported to have eased to 4.6% in December, but that will provide no change to the government`s assessment of the current situation, and the need for rate increases, since price pressures in the commodity market, and the domestic sector leave very little room for any delay of the necessary action. We should recall that the government`s inflation target is just 3%, way below the 4.6% just mentioned.
The expectation of Chinese tightening has battered gold prices, which were lower to as much as $1345 per ounce during the last day of the week, as oil was similarly sold, losing around 2.65% off its value in Friday`s trading. We expect the difficulties in the commodity market to continue for the first half as the Chinese need to tighten is very real. In any case, prices of some commodities like silver and oil are probably already out-of-synch with their fundamental and technical trends, so a reversal of course will not be surprising. Still, we don`t expect the Chinese to be too aggressive with their tightening, and since the Fed will keep undermining the dollar, commodity trends will survive in the longer term, barring a major catastrophe such as a disorderly breakup of the Eurozone.
In separate developments, in a speech today Hu Jintao, the Chinese President, emphasized the necessity of "U.S. respecting Chinese sovereignty over Tibet and Taiwan", warning that acting in the opposite direction would create tensions in the Asia-Pacific region. He was rather frank in his words, saying that the history of bilateral relations shows the potential for steady growth if the countries respect each other`s points of sensitivity, concluding that "otherwise our relations will suffer constant trouble or even tension".
China`s concerns about about Tibet and Taiwan are well-known, of course. The Tibet issue is probably the easier one, since, apart from the well-publicized protests of the Dalai Lama, and the occasional censure of various international bodies and U.S. Congress, there is not the remotest possibility that the Tibetans will be able to throw away the yoke imposed on them, or that the Chinese will face any significant security risks. India, which is the only relevant Asian backer of the Dalai Lama, has been trying to improve relations with the Chinese recently, and another conflict over the Aksai Chin or any Tibet-related issue seems extremely unlikely.
The Taiwan problem is an altogether different matter. We believe that the Chinese are make a mistake by playing their cards so openly, and leaving no room for doubt in their relations with the Americans. Arguably, this is born of their desire to maintain stability through an effective diplomatic deterrent, in that, if their partners and rivals are aware of what they will not be tolerating, the risk of a conflagration should be expected to be lessened. This approach makes sense from a Chinese point of view, since they see themselves as the righteous aggressors over the Taiwan issue, defending Chinese honor and power against the humiliation of the past centuries. It also means that the Chinese do not expect the Americans to make a first move, such as inciting the Taiwanese to some declaration of independence, or an equivalent action that would force them to take action in terms defined by the U.S. It is unclear how much of a risk this poses for China over the longer term.
Apart from the propaganda value of such a stance, it is hard to see what strategic benefit the PRC gains from its current stance on the Taiwan issue. The U.S. can at any moment trigger a highly predictable Chinese response by encouraging the Taiwanese leadership to be more aggressive about the independence issue, potentially creating a crisis situation in which the Chinese have little opportunity to adapt to the emerging situation. The PRC leadership is, undoubtedly very well aware of this risk, and its very buildup of forces in the region, strong concentration of naval and air forces is probably directed at giving a clear sign of how powerful its response will be in case that a Taiwan crisis emerges. President Hu`s recent comments in the U.S. emphasizing this point, are to be understood in this context, and not a sign of belligerence or hostility, in our opinion.
On the CNY issue in Washington, Democratic Representative Sander Levin of Michigan is reported to be planning to introduce a legislation as early as Monday next week, which will be reproducing the language of a similar bill passed by the House in September 2010. Hu`s response, while being questioned on it by senators, was that the problem is that "we, the China are more productive", and "have lower labor costs", according to Senator John McCain. Not very constructive, but one cannot expect Hu to say much else either. We are surprised that he was so candid with his answer.
In short, Friday was not a good day for stocks, commodities, or risky currencies, with the dollar, yen, and bonds generally being the better performers. We don`t expect this to change much in the near term, with the trigger point being signalled by Chinese rate rises, and their end marking the reinception of the previous bull trend. On U.S.-China relations, the main concern remains the currency issue, since, as both political parties are deeply out of touch with voters, it is but a matter of time that the politically lucrative, and low-cost USDCNY issue becomes too enticing a target for exploitation. In the meantime, smiles will be maintained, since big business has as big a stake in seeing the status quo continue just as the Chinese leadership does, and with so much cash to spread around, it seems that the resolution can be delayed for quite a while.
Bourses have been doing very well today, as European stocks outperformed U.S. equities. Asia is also showing a strong performance, with Japan being the main weakness in the region. Low volumes, and lack of meaningful data has been exploited by those few who are active in the market in order to drive prices higher. Bigger actors are probably evaluating the year and keeping trade volumes to at a minimum.
Data from the U.S. continues to be positive in line with our generally U.S.-positive outlook for next year, although this does not imply that the USD is a good choice for safety and stability. The U.S., like Japan, is going through a period of recuperation and readjustment, which, by definition, does not involve radical changes and upheavals. The shocks and scandals are mostly over. The GSEs are nationalized, Madoff is in jail, investment banks are no more, government intervention is ubiquitous, the private sector is continuing to cut costs, while the consumer is cautious about risk taking, after seeing what happened to the foreclosed neighbor, or the laid-off worker. None of this is good from a growth perspective of course, but slumber is better than panic or intoxication, two states between which the rest of the world seems to oscillate as a great deal of effort is made to place events and actors into context.
In many ways, the U.S. is benefiting and will benefit from being the first to suffer the consequences of the global speculative bubble that developed, in large part, after the goobal interest rate cuts at the beginning of the century. Yet there can be no doubt that no nation will be isolated from the consequences. Imbalances are not troublesome for those in deficit, they are also troubling for lenders, as the spate of foreclosures in the U.S. has demonstrated to great effect.
No one has ever thought that big banks would be fine while borrowers defaulted just because they happened to be on the opposite side of the mortgage transactions. What would convince us, then, that just because China and the Asians are creditors, they will fare better than the borrowers in the Western World. If Citibank or Bank of America suffer when homeowners default, why do we believe that the Chinese will be fine, when they are the real lenders, after all, to cause all the massive bubbles and balloons on this side of the ocean?
The Chinese can no longer inflate America and its markets in order to create demand like they did in the past, so the wise government there is now applying its addictive medicine to its own economy in order to create the same fake demand that all but destroyed the U.S. economy during 2007Q3-2009Q1. Just like most speculators were blind to the mortage bubble back then, they are blind to the domestic Chinese bubble now, believing that, because the Chinese have huge cash reserves and a strong export sector, they can weather any storm. This argument is in fact very similar to that advanced in defence of Merril Lynch, Lehman Bros, and others, when they had almost incredible profits during the boom years. Yet those profits did not prove sufficient to save them from bankruptcy, because of the crucial term, "leverage". And so, what makes us believe that the Chinese will be able escape the cataclysmic consequences of their own bubble blowing, once their gigantic edifice of leverage and monetary inflation collapses, as it inevitably will?
The developing world story is a real story, and in spite of all the risks, the gains that have been made over the past two decades are real and will lead to a real convergence in performance around the world. We are convinced that the days when certain parts of the world were permanently backword are over for now. The immense improvement in communication technologies, the widespread availability of information at all levels has accelerated the pace at which knowledge is shared around the globe, and, as most people believe, permanently improved the growth capacity of the world as a whole. But none of this excludes the possibility that bubbles will develop, and none of it implies in any way that people, investors, or voters have become any wiser. All that it means is that they have become more similar, and their actions and choices are easier to analyze with a single set of data that is applicable to very different geographies and cultures. The fact that few nations, perhaps with the exclusion of sub-Saharan Africa, for now, will be left behind in technological and scientific advancement of the human race does not mean that the human race as a whole cannot go through difficult and turbulent phases. Indeed, the basic law of oscillations makes us think that the more momentous the upward swings are, the more momentous the downward movements will be.
These facts remain facts as long as the global economy is run by people who are delighted to see citizens enjoy the fruits of temporary bubbles and dreams. Emotional approaches towards economic issues is bound to yield disastrous consequences, as history has shown us time and again, but let`s allow our hearts the freedom to have more hope these days, as the year approaches its end.
