Will August 2009 be the top for the year in China?

August 23rd, 2009

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Last time, it used to be that the US stock market ‘leads’ the world’s stock market. As the saying goes, when America sneezes, the rest of the world catches a cold. If the Dow Jones plunges, the stock markets in Europe and Asia will likely ‘follow.’ Recently, over the past few years, a curious phenomenon seems to be occurring more often- the US stock market is ‘following’ the rest of the world, particularly China.

Indeed, the stock market is a fine example of the study of human herd behaviour.

Now, as every investor or trader should know, the Chinese stock market had fallen around 20% from the early August high. In our view, it is likely that this will be the high for at least 2009. Why?

Back in Is China setting itself up for a credit bust? and How big is the credit bubble in China?, the Chinese government was force feeding large quantity of credit into the Chinese financial system. Unlike in democratic Western countries, Chinese banks cannot refuse to follow the directives of their central government. They had to lend in order to reach a target set out by the government. As we all know, the collapse of the Chinese export sector was putting downward pressure on the economy. As a result, private demand for credit was anaemic.

If the banks had to lend and businesses did not want to borrow, what then?

Then the Chinese business culture of doing favours for each other kicks in. The credit-worthy businesses that the banks lent to (who have no expansion plans in the face of dwindling foreign demand), took the money nevertheless. Then the monies was poured into the stock and property market. That’s why both the property and stock market boomed so quickly after a dramatic collapse from last year. It is also likely that some of the monies are used to speculate in commodities- how can the divergence between real Chinese demand and commodity prices be explained?

In July, it was widely reported in the news media that the Chinese government clamped down on new loans. Consequently, loan growth plunged. If a raging bull market is financed by credit, then all it takes is a dramatic slowdown in credit growth to crunch the bull market. Below is the graph of China’s credit growth:

Chinese loan growth
Click on graph to see it in full size

One interpretation sees the Chinese government as still learning the ropes of capitalism. Forcing credit growth in this case does not result in economic ‘stimulation.’ Instead, the result was a dangerous asset price bubble. Apparently, the Chinese government flipped its position and decided to rein in the bubble before its too late.

The question is: what is the implication of this on commodity prices? And will the rest of the world follow?

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