5th December 2008

Some Chipped China?

We are by now quite used to those more descriptive Chinese expressions and terminology – they often seem to come with references to wildlife and nature as well as a more Confucian style. Most recently though, this illustrative style seems to have been replaced with a more blatant and blunt language which reflects the more difficult economic situations that this nation is now facing. The authorities have most recently taken to describing the country’s employment outlook as just “grim” – a very un-oriental description. It seems that urban unemployment has been increasing significantly as demand for exported goods have fallen back, and this now puts the administration into a very awkward situation.

This changed financial environment is a new and disappointing world for the Chinese authorities. Until now the unofficial “deal” has been quite straightforward – “yes you can leave the farmland and come to the cities and work hard in awful living conditions away from your family, but you will have the opportunity of getting onto and clambering up the ladder. Once on the bottom rung of the ladder you too will have at last the chance of climbing as high as you can”.  However, now someone has just taken away the lowest rungs! The dream of climbing out of the “slough of despond” has been taken away and replaced with the painful hunger of forbidden fruit, rejected opportunities and a negative outlook. Not the best thing for a developing and emerging population.

One of the great fears for the authorities, especially an authoritarian oligarchy, is the fear of social unrest and destabilisation. There have already been many thousands of examples of social “unrest” with riots in Gansu province for example (not including the issues relating to Tibet of course), of which, not unsurprisingly, we hear little, and such economic frustration is quite likely to lead to more of the same. It is hardly surprising therefore that the authorities have stated that “stabilising employment is the top priority for us just now”. Traditionally this would be solved by returning the new urban population to their rural roots, and those that could not do so would enjoy the somewhat limited international opportunities of an extended career in the People’s Revolutionary Army. Both are still possible but once the chance of advancement has been let out of Pandora’s Box, it will be supremely difficult to suppress the aspirations and desires of so many.

The authorities readily admit that this has been caused by the slowdown in global demand for Chinese goods and especially from their primary export market of the USA. With Europe now also in recession, these alternative markets which might have been able to pick up any slack in demand won’t really be able to help either. Time then for some clear reassessment domestically. The authorities may consider that excessive unemployment is unacceptable and that other actions may be necessary. State support may be one route, or potentially the dumping of low cost goods – however, maybe the more effective answer should be to stimulate domestic demand. With foreign exchange reserves of over $1.8trillion, there is no shortage of cash to be deployed by the Chinese and, if effectively used, it would encourage further economic growth and demand both domestically and internationally.  The authorities have already unveiled further rate cuts (down to 5.58%) and a $590billion package of partially new money, but in terms of the scale of this nation this is little more than a few drops in the Yangtze.

I suspect more will follow, but expecting nervous consumers to rush out to buy consumer goods in economically worrying times is a distant hope. They will behave just as we do in times of concern – stop and save. However infrastructure, service and healthcare developments may well see more concentration and that would be good news for overseas exporters providing specialist facilities and needs. We must wait and see.

If global trade is a partnership, then now is the time for those who have amassed the reserves over the years to play their part in keeping the recycling going – that of course does not mean handing the loot back, but rather ensuring that the very economy they have benefitted from so much is able to continue on to the next stage of the cycle.

China of course is not alone in this. The nations with trading surpluses should be looking to keep the process going. So as well as China, we can add Japan, the Middle East and Germany to the list. For those malingerers with their deficits, like the US and UK, they will have to learn the responsibility of sound financial management as well as learning to live within their means. Something that the Chancellor of the Exchequer  was reminded of last week as he sought to borrow and spend his way out of our recession with our debt. The UK should wake up – the rules have changed – we are no longer an oil exporter and cannot afford to live beyond our means.

One measure of the dramatic slowdown in global trade can be seen in the charter rates for ships – an equivalent charter rate for a ship two years ago was about $26,000 per day – for the same vessel this would now be $6,000. The China effect in reverse!

Some good news at last – the President Elect is assembling his team and has set the economy as his priority – and as part of this new team comes an old but much respected name – Paul Volker – Alan Greenspan’s predecessor and the man who sorted out the Savings and Loans scandal back in the 1980’s.  Now he may not be of Harry Potter’s wizarding capability but he certainly brings the credibility of someone who could properly understand and address these vital issues.

And finally... to follow on from the Pre-Budget Report – also known as “Never has so much been wasted to achieve so little” - there was an interesting reaction in the Credit Default Swap (CDS) market. The cost of insuring against default of UK Government debt has risen to a record of 0.97%, or in plain English it now costs �£97,000 to insure �£10 million of UK Government debt for five years. Interesting possibly but more concerning when you consider that a Unilever CDS only costs 0.67%! So who is more slippery, a margarine manufacturer or a UK politician?

Have a good weekend,

Justin A. Urquhart Stewart
Director
Seven Investment Management Limited

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