China Redux

Top Chinese officials are openly warning of a bubble in the stock market. At least three state-run papers ran major stories about a recent warning from Zhou Xiaochuan, governor of the People’s Bank of China, who said that he was concerned about the bubble, reports the Financial Times.

But investors were unimpressed and the market didn’t skip a beat, rising three percent in trading Tuesday.

In a post three weeks back, I wrote that “there’s a lot of complacency” in the market and that Chinese officials didn’t seem to be doing much to address the situation. The reality is proving a bit more complicated, of course.

Chinese officials are trying to talk down speculators, but to no avail. In the past, strong statements about the market have strongly influenced share prices (as with the Federal Reserve in the United States). But times have changed, the FT notes, and “the admonitions of senior officials seem increasingly impotent.”

So why have investors stopped listening to official warnings? One explanation is that they’ve become desensitized to all the talk. Officials have so far resisted any decisive moves, such as ticking up China’s low interest rates.  But authorities appear unwilling to do anything that could actually slow the country’s torrid growth.

So China’s investors are calling their bluff.

Of course there are other, less rational reasons to disregard the advice of China’s top economic officials and stop worrying about the bubble: some people just like to gamble.

Deja vu. Chinese investors — many of them regular citizens hoping to hit the jackpot — are ignoring the lesson of February’s correction in the Chinese markets (read post here) and rushing back into the circus. Money is pouring in from all directions, as the FT reports: “In the last week alone, more than 1m new accounts have been opened, taking the total for the last four months to more than 10m – greater than the previous four years combined.”

The carnival-like atmosphere is just one reason to stay away from the Chinese markets — here are a few more. There was a roughly 9 percent correction in the Shanghai and Shenzhen markets in February. But the Chinese markets are still up 40 percent so far this year, after rising more than 130 per cent last year after a prolonged bear market. From an expert at HSBC:

This is definitely a bubble in the making – for most stocks, positive earnings growth has been priced in until 2009,’ said Steven Sun, HSBC equities analyst. ‘At the height of the last bubble [2000-01], we saw investors opening 2m accounts a month, which is half the current rate.’

While the number of accounts opened alone should not define a bubble, it certainly should raise a red flag for sensible investors.

It’s a sad story, really. “Any money getting into the market now is not smart money and is coming from the kind of people who can least afford to lose it,” said Fraser Howie, author of a book on the Chinese stock markets (via the FT). “That has to have the government worried about social stability.”

Is it just me, or does it seem as if there’s a lot of complacency, i.e. people are more or less resigned to a boom-bust cycle? Is the government taking action to cool the market? Aside from limited public warnings on the risks of investing, I have not heard of any movement to address market conditions.

UPDATE: Just hours after after I posted this story, the Shanghai Composite Index dropped 4.5 percent (it was 7% percent lower at one point) on news that China’s economy grew 11 percent in the first quarter of the year, raising concerns that the  government would seek to raise interest rates to curb overheating.  Just as in February’s market correction, the Nikkei felt the repercussions and lost nearly 2 percent, along with other Asian markets (Singapore, Hong Kong, Thailand), which roiled European markets, which will lead the Dow way down to start the day.

News of Commerce’s decision to impose countervailing duties on imports from China has set the blogosphere astir. Among the most interesting are China Hearsay’s post on the legal justification for the action against glossy paper imports from China, and China Matters’ political background on the case (here).

This is definitely a big deal, no less because it is the first time that countervailing duties will be imposed on imports from a non-market economy. How far will enforcement go? As China Matters point out, the action against paper imports could theoretically be applied to an array of Chinese goods. So while this is one small step towards towards protectionism, it could lead to one big leap.

Countervailing duties are perhaps the ultimate political and economic weapon in trade wars, and the Bush Administration has apparently decided to trot out its trump card. CVD duties would result in significant increases in the cost of Chinese goods, while marshalling domestic political support by creating the perception of a more level playing field for American manufacturers.

While there’s been no official response from China as of yet (the move was announced on a Friday afternoon, a favorite administration tactic and a sign of some sheepishness on its part), I imagine this puts the fear of God in them. China can either call the bluff, complain to the WTO, and see how far this thing goes, or it can accede to US pressure by revaluing the yuan. Either way, the move represents significant, tangible external policy pressure on the Chinese government, which they are bound to deplore. It’s one of the Chinese government’s pet peeves.

The reality is that no matter how the CVD duties are applied and how this plays out, CVDs are reactive measures that fail to address underlying economic conditions. So Commerce’s tactic could force China to rethink and accelerate the pace of its currency reform. And then what? As numerous economists have shown, appreciation of the yuan will not fix the US trade deficit. It could make loads of goods more expensive for US consumers. And neither currency reform nor CVDs are going to bring back manufacturing jobs to the US.

Ultimately, countervailing duties and/or currency reform will not alter the global economic landscape in a significant way. Imposition of CVD duties, however, could buy valuable time for US politicians and businesses as they figure out a strategy to compete more effectively with rising China. If that’s the strategy, it could be a long, ugly struggle. But someone better come up with a different set of tactics for increasing US competitiveness, rather than simply reacting to China’s gains.

In the midst of the market tumble, some interesting new economic stats got lost in the shuffle: in the past 18 months since the revaluation of its currency, Chinese exports have become more profitable. This despite the nearly 6.5 percent appreciation of the remnibi against the dollar and higher prices for raw materials.

The news likely benefits neither side in the tug of war between the US and China over the latter’s currency valuation (see my earlier post here). The FT’s Richard McGregor breaks it down in his story from last week:

The extra cash garnered by exporters confounds the arguments of domestic opponents of currency revaluation, who argued any rise in the renminbi would erase the small profit margins of Chinese exporters.

The ongoing competitiveness of China also underlines how any focus by the US in trade talks on the currency alone will not be effective in rebalancing bilateral economic ties.

With no clear change in the playing field, I’ll stick by my earlier claim that this item goes nowhere until Chinese officials feel good and ready to move on appreciation, in spite of persistent pressure from Treasury Secretary Paulson (via Yahoo). Read the rest of this entry »

Can’t resist the temptation: Told you so.

But it wasn’t just China that took a beating, as the WSJ’s Marketbeat points out. Every major market around the world dipped significantly at some point today. No question it demonstrates China’s growing importance to the global economy, both real and symbolic.

The market correction also showed the impact of weakening economic fundamentals in the US and elsewhere (see the drop in durable goods announced today, which didn’t help things). There’s no guarantee markets will rebound strong tomorrow. But if I had been planning to put some money to work in the US or Chinese markets, I would think that now would be as good a time as any to make an entrance. Not for the faint of heart, though.