Archive for the ‘china’ Category

There were about five pieces of news on Friday that delivered such a massive upside kick to oil.

1) Chinese oil consumption numbers came in much higher than expected.

Wall Street is still being blindsided by the impact of the Sichuan earthquake, and apparently most of it is ignorant that ~30 percent of Chinese oil/ natgas/ heating oil comes from Sichuan and Gansu (which was also thrown into chaos by the quake).

2) Shaul Mofaz rattled Kadima’s flimsy sabre at Iran, again. Anyone who took that seriously is ill-informed.

3) The dollar continued hemorrhaging. Brokers are cutting back trading with Lehman Brothers, and Bernanke will probably be called out on his fateful March 17 nationalization of banks’ default risk. He will have to throw hundreds of billions of dollars in Treasuries at Lehman’s crippled balance sheet, further debasing Treasuries specifically and US financial credibility generally.

4) Morgan Stanley said oil would go to $150.

5) The USD and EUR are both heavily overvalued. As long as China keeps its currency peg alive, the dollar and euro will both be overvalued. The only other large currency alternative is commodities, so that’s where money is going.

As I have said many times, government witch hunts against “speculators” never signal the top of a bull market.

Israel’s saber-rattling might have been good for 1 percent of oil’s gain. Obama’s triumph in the US presidential primaries multiplied that, for a total of maybe 3 percent.

In the meantime, Asia’s cracking currency regimes are effectively increasing their subsidies of fuel.

HONG KONG: Buckling under the weight of record oil prices, several Asian countries have cut or are thinking of cutting their fuel subsidies, which raises a pressing question for Beijing: Can China afford its own oil subsidies at a time when it is spending billions on post-earthquake reconstruction?

The short answer is yes, because China is blessed with both large trade account and fiscal surpluses. The reconstruction cost is projected to amount to about 1 percent of China’s gross domestic product, while the fuel subsidies account for another 1 percent, JPMorgan estimates.

Remember that China had a fiscal surplus of 0.7 percent of gross domestic product last year, or $174 billion. So even if spending on post-earthquake rebuilding and fuel subsidies were to cause a 1 percent fiscal deficit, that would still be very manageable.

But here is a more important question: Why should China keep domestic fuel prices at about half of the global average?

The usual answers are to keep inflation in check and stave off social instability that could result if prices were to rise too quickly.

But by distorting fuel prices, China is encouraging fuel consumption and discouraging the use of new energy. Since the Chinese still live in an $80-a-barrel oil environment, demand for anything from cars to chemical products will spiral higher and raise the risks of economic overheating.

Increasing subsidies on fuel will crowd out more investment in other areas, such as education or health care, to name two possibilities.

What’s more, a worsening fiscal situation might put downward pressure on the yuan. Fuel subsidies have exaggerated inflation in the developed world, while understating inflation in the developing world. China’s inflation could well hit 15 percent if Beijing were to free up caps on energy prices, Morgan Stanley estimates.

“If China is not able to take away the subsidy and cut down its demand, it will have huge implications for the world,” said Shikha Jha, a senior economist at Asian Development Bank.

Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan.

Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize them, the less likely high oil prices will have any affect in reducing overall demand, forcing governments in weaker financial situations to surrender first and stop their subsidies.

That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India and Malaysia have either raised regulated fuel prices or pledged that they will.

Actions taken by those countries will not be able to tame a rally in prices though unless China, the second-largest oil user in the world, changes its policy. While the West is critical of China’s energy policy, there is little outcry for change within the country, except for complaints from two loss-making refineries.

By contrast, Indonesia has convinced its people that fuel subsidies benefit the rich more than the poor, because rich people drive more and consume more electricity. Jakarta rolled out a $1.5 billion cash subsidy program to help low-income Indonesians cope with higher prices. Although no country wants to build a system on subsidies, the cash subsidy at least makes fuel subsidy cuts politically feasible.

“The people need to wonder, who pays for the subsidies?” said Louis Vincent Gave, chief executive of GaveKal, a research and asset management company. “Most Asian countries are printing money to pay for them.”

Fuel subsidies compromise countries’ ability to control their own budget spending. If China and India can cut their subsidies, they would be able to spend more on infrastructure and education.

While Asian governments dole out cheap food and cheap energy, Asian currencies settle the bill. Morgan Stanley expects some emerging market currencies to face downward pressure, probably for the first time in a decade, as those countries unwind their fuel subsidies and domestic inflation shoots up.

China’s domestic fuel prices are among the lowest in the world, equal to about 61 percent of prices in the United States, 41 percent of Japan and 28 percent of England. The longer it waits, the more painful it will be when it tries to remove the subsidy.

China actually doesn’t have much freedom to splash dollars for fuel. Its entire macroeconomic policy can be summarized as “long USD, short RMB.” Not a good trade.

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Setser on the PBOC:

What cann’t go on still hasn’t slowed, let alone stopped (Chinese reserve growth)

… Back in 2004, it was considered rather stunning when China added close to $100 billion to its reserves ($95 billion) in a single quarter, bring its total reserves up to around $600 billion.. The dollar’s fall against the euro (and associated rise in the dollar value of China’s euros) explains around $15 billion of the rise. But at the time, $80 billion was considered a very large sum for China to have added to its reserves.

Now China has $1756 billion in reserves, after a $74.5 billion April increase. The dollar rose against the euro in April, so the underlying pace of increase – after adjusting for valuation changes – was more like $82 billion.

In a month.

And not just any month – in a month when oil topped $100 a barrel.

$82 billion a month, sustained over a year, is close to a trillion dollars. A trillion here, a trillion there and pretty soon you are talking about real money. If a large share of China’s reserves is going into dollars, as seems likely, this year’s increase in China’s dollar holdings could be almost as large as the US current account deficit.

The fact that one country’s government – and in effect two institutions (SAFE and the CIC) – are providing such a large share of the financing the US needs to sustain large deficits (particularly in a world where Americans want to invest abroad as well as import far more than they export) is unprecedented.

The real surprise in some sense is that the increase in China’s April preserves isn’t that much of a surprise. At least not to those who have been watching China closely.

Wang Tao – now of UBS – estimated that China added $600 billion to its foreign assets in 2007, far more than the reported increase in China’s reserves. Logan Wright (as reported by Michael Pettis) and I concluded that Chinese foreign asset growth – counting funds shifted to the CIC – could have topped $200 billion in the first quarter.

China hasn’t disclosed how much it shifted to the CIC, let alone when it shifted funds over to the CIC. But it seems likely that the surprisingly low increase in China’s reserves in March stems from a large purchase of foreign exchange by the CIC. Indeed, the CIC’s March purchase may have used up all of the RMB 1.55 trillion the CIC initially raised.

As a result, all of the increase in the foreign assets of China’s government seems to have showed up at the PBoC in April. Or almost all. China raised its reserves requirement in April, and the banks may have been encouraged to meet that reserve requirement by holding foreign exchange.

China’s current account surplus – adding estimated interest income to its trade surplus – was no more than $25 billion in April. FDI inflows were around $7.5 billion. Sum it up and it is a lot closer to $30 billion than $40 billion. Non-FDI capital inflows – hot money – explain the majority of the increase.

No wonder Chinese policy makers were so focused on hot money this spring. Hot money flows seem to have contributed to their decision to stop the RMB’s appreciation in April. But interest rate differentials still favor China – so it isn’t clear that a slower pace of appreciation will stem the inflows.

It certainly though helps to sustain the underlying imbalance that has given rise to massive bets on China’s currency.

The scale of China’s reserve growth suggests that China’s government is no longer just lending the US what it needs to buy Chinese goods. And it is now lending the US – and indeed the world – far more than the world needs to buy Chinese goods. Vendor financing is a fair description for China’s reserve growth in 2003 or 2004, but not now.

China’s government is increasingly acting as an international as well as a domestic financial intermediary. It has long borrowed — whether through the sale of PBoC bills of Finance Ministry bonds to fund the CIC – rmb to buy dollars, effectively taking the foreign currency domestic Chinese savers do not want to take. Now though it is borrowing from the rest of the world to lend to the rest of the world.

Most intermediaries though make money. Or at least try to. By contrast, China’s government is almost sure to lose money on its external financial intermediation. Selling RMB cheap to buy expensive dollars and euros is not a good business model.

China cannot be entirely comfortable with all the money that is pouring into China. But it isn’t at all clear that Chinese policy makers are willing to take the steps needed to shift decisively toward a new set of policies. It is clear that the costs of China’s current policies are rising.

Remember, China looses [sic] money on its reserves. More isn’t better.

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Apparently luck had it that every single Chinese ADR, and more than a few others, trooped to the United States to make their pitches to US investors. I got to listen to more than a few of them over the past four days (one reason why the post count has run low).

American institutional investors are quite concerned about the post-Olympic dampening effect, and are also concerned about inflation. The CFOs I talked to informed me that their internal inflation forecasts are running in the 12 to 15 percent range, basically dependent upon whether they think China’s price blowout (recently concentrated in food) is permanent or transitory.

While the meteoric increase in food prices has abated somewhat, oil and metals have gotten worse. Chinese manufacturers, refiners, and banks are eating fierce losses. The distribution of said losses among the three groups is unclear, but the existence of enormous losses is a matter of fact.

The CFOs I talked to generally represented IT companies, which are heavily insulated from raw materials inflation, if not wage inflation. I would imagine the outlook at more BTU-intensive companies is significantly worse.

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The Age (Aus.):

Justin Norrie, Tokyo

April 21, 2008

A 130% rise in the global cost of wheat in the past year, caused partly by surging demand from China and India and a huge injection of speculative funds into wheat futures, has forced the Government to hit flour millers with three rounds of stiff mark-ups. The latest — a 30% increase this month — has given rise to speculation that Japan, which relies on imports for 90% of its annual wheat consumption, is no longer on the brink of a food crisis, but has fallen off the cliff.

MARIKO Watanabe admits she could have chosen a better time to take up baking. This week, when the Tokyo housewife visited her local Ito-Yokado supermarket to buy butter to make a cake, she found the shelves bare.

“I went to another supermarket, and then another, and there was no butter at those either. Everywhere I went there were notices saying Japan has run out of butter. I couldn’t believe it — this is the first time in my life I’ve wanted to try baking cakes and I can’t get any butter,” said the frustrated cook.

Japan’s acute butter shortage, which has confounded bakeries, restaurants and now families across the country, is the latest unforeseen result of the global agricultural commodities crisis.

A sharp increase in the cost of imported cattle feed and a decline in milk imports, both of which are typically provided in large part by Australia, have prevented dairy farmers from keeping pace with demand.

While soaring food prices have triggered rioting among the starving millions of the third world, in wealthy Japan they have forced a pampered population to contemplate the shocking possibility of a long-term — perhaps permanent — reduction in the quality and quantity of its food. …

… Last week, as the prices of wheat and barley continued their relentless climb, the Japanese Government discovered it had exhausted its ¥230 billion ($A2.37 billion) budget for the grains with two months remaining. It was forced to call on an emergency ¥55 billion reserve to ensure it could continue feeding the nation.

“This was the first time the Government has had to take such drastic action since the war,” said Akio Shibata, an expert on food imports …

Biofuels companies are going to be destroyed by this. Agribusiness — especially anything having to do with genetically-modified food — will blast off. This isn’t going away in 2 quarters.

Thailand, one of the world’s biggest rice exporters, is only the latest country to be mauled by a massive drought.

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Things started getting very difficult with the internet about six months ago as the great firewall got tighter, but in the past few weeks internet access has been far more frustrating than it has ever been during my over six years living in Beijing.  It takes me hours (literally) to post anything on my blog.  My Peking University students tell me that they waste two or three hours a day more than they used to trying to access information on the internet.  When I ask them why it has become so difficult, they tell me that there are a lot more things now that the government doesn’t want them to know – although they don’t usually specify what that may be. …


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China’s chronic undervaluation of its currency implies that the country should have a rate of inflation approximately proportional to its persistent current account surplus. China’s current account surplus has been exploding recently, which means that China is in the throes of an inflationary monetary trap. It also means that you can look at China’s forex reserves as an approximate indicator of what China’s real rate of domestic inflation is.

One of the methods by which China has kept its (stated) rate of inflation so low has been by a haphazard series of price controls, especially since last fall (justified by chronic “one-off events” — pork disease killing lots of pigs, a big snowstorm, etc). However, that system is breaking down.

March 28, 2008 | 1307 GMT

For the first time since Beijing imposed a temporary ban in January on all price increases for essential items, China’s National Development and Reform Commission has allowed a price rise application to slip through. In reality, this ban was more effective at calming social unrest ahead of March’s politically sensitive National People’s Congress than resolving China’s inflation problem at the root. Going forward, the government will have to look for other, more effective ways of curbing inflation — if none is found, a temporary ban will likely be reimposed.


China’s third-largest dairy producer, Bright Dairy & Food Co., said March 28 it plans to raise milk prices by 14 percent in some regions after having obtained approval from the National Development and Reform Commission (NDRC), Shanghai Securities News reported.

For the first time since January, when Beijing imposed a temporary ban on price hikes from all major producers of essential items such as milk, flour, rice, noodles and cooking oil — subject to central government approval — the NDRC has given a major producer permission to raise the price of an essential food item. […]

Currency manipulation is today’s favorite mode of capital allocation by authoritarian governments. One of the side effects of Bernanke’s war on the dollar has been to dramatically raise the cost of this policy, which pegs the national currency to the USD at an artificially low rate to boost exports, and misallocate capital to the export sector, at the expense of domestic purchasing power. A cheaper dollar drags down all currencies pegged thereto, which means that the purchasing power of phony-currency pegs’ citizenries erodes further, which causes more social instability and unrest.

The power of the 1989 Riot Which Shall Not Be Named was in the population’s rage at food price inflation … not the seductive appeal of the “goddess of democracy.”

A 14 percent price increase is going to hurt a lot of pocketbooks.

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March 5, 2008 | 1331 GMT


Ten Australian tourists and their translator were taken hostage March 5 in the Chinese city of Xian, famous for its terra-cotta warriors.

A local Xian resident identified as Xia Tao boarded a tourist bus at around 9:52 a.m. local time, armed with explosives and threatening to blow up parts of downtown Xian. Local police negotiated with Xia, who released nine of the Australian hostages before transferring to another bus with one Australian and the translator and driving to the airport. Police shot and killed Xia as he approached a tollbooth near the airport. The remaining hostages were unhurt. Police have not released Xia’s motive.

I haven’t heard of a single incident like this before. But I suspect that generalized economic malaise, i.e. inflation, was what caused this. Inflation is the root cause of very serious latent social instability in China, about which Western investors are as clueless as ever. Inflation-driven unrest shook the Communist regime to its foundations in 1989, destroyed the Guomindang Nationalists in the 1940’s, and will shake China’s current regime to its core within the next five years.

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