China is slowing down

March 23rd, 2011

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Many things happened since we last wrote. The earthquake in Japan was the biggest news of the day. As Japan’s nuclear crisis unfolded, stock markets around the world panicked amidst screams of “nuclear meltdown.” Today, the nuclear situation in Japan seemed to be stabilising, even though the long-term radiation impacts are still unclear at this moment.

To help you keep things in perspective, please note one thing about Japan’s nuclear crisis: despite screams of “nuclear meltdown,” there is ZERO chance of a nuclear explosion. A nuclear reactor is NOT a nuclear bomb. Our guess is that this nuclear crisis is just a blip in the economic big picture, even though in some localised areas in Japan, it is the end of the world (e.g. some areas may not be habitable for a long time). Therefore, contrarian investors may use this opportunity to buy Japanese stocks (we know it is probably too late to do so now).

However, do not let the nuclear crisis distract you to a more important development that is already brewing for quite some time- the coming slowdown in China. This development is far more important than the Japanese nuclear crisis, which by now is no longer a crisis. Remembered we wrote in January last year at Chinese government cornered by inflation, bubbles & rich-poor gap,

By not allowing the yuan to appreciate, the Chinese government shows that at least for now, they fear unemployment and excess capacity more than inflation.

But there will be a day when they have to tackle the inflation problem. As long as the inflation problem is not solved, there will be rising prices and bubbles in the asset markets.

Today, we can say that the Chinese government are tackling the inflation problem. 2009 and 2010 was the year when they pumped in steroids into the economy. Today, they are dealing with the effects of the steroids- price inflation. China is tightening monetary conditions (e.g. rising interest rates, increasing bank reserves requirements) for quite some time already. They are serious about dealing with price inflation, at least for now. Premier Wen Jiabao had already declared that China’s target for economic growth will be lower (see China lowers growth rate target in sustainability drive), from 8% to 7%. Incidentally, the lower target of 7% is pretty close to Gary Shilling’s (a respected bear on China) definition of a ‘hard landing’ in China, which is a growth rate of 6% or less.

So, it should be extremely obvious by now that China’s economy will slow down this year. In other words, China is aiming for a soft landing.

The big question is, when the slowdown begins to bite, will China step on the accelerator again? Our belief is that there’s too much vested interests in China to keep the growth going and to prevent the bubble from bursting spectacularly. Also, the central bank in China is not independent. Thus, as we wrote in Why should central banks be independent from the government?, without an independent central bank, the bias in China is towards more inflation.

The risk for China (and by extension, Australia- see Turkeys fattened for slaughter in the Chi-tralia bubble) is that the control freaks in Beijing may stuff up and either turn the soft landing into a hard landing or losing control of inflation.

Watch this space.


  • Enzo

    Great article – I’ve been saying this to the China bulls now. Hopefully your article can dispell then false euphoria