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China’s Grinch Raises Rates on Christmas

Submitted by Jack H Barnes on 12/26/2010 01:32 -0400

China’s Grinch Raises Rates on Christmas

For
the second time in the last few months, China’s Central Bank has raised
its rates to fight internal inflation. The new rate goes into effect
Sunday. Here is an English version of their announcement.

The surprise action taken when almost no one would be around to
notice, verses waiting until the start of the new year gives the Bank a
chance to cause a further tightening as some investments reset their
base rates at the beginning of the new year. This gives all of those
loans a higher internal rate for the next year.

“This rate hike demonstrates Chinese authorities’
determination to keep inflation under control up front, or front-loaded
tightening,” said Qing Wang, chief China economist at Morgan Stanley
in Hong Kong.

“Compared to rate hikes in the beginning of next year, a rate hike
before year-end will have a more tightening impact, as the interest
rates on the medium- and long-term loans and deposits are reset at the
beginning of each year according to the base rates.”

Once expectations of inflation are ingrained into an economy, and
currently China shows all signs of that event, it takes a Vockler type
event to kill it. While China is attempting to do this, with out
slowing or stalling its economy, the world is starting place bets on the
outcome.

“We expected a rate hike by the end of the year, though
Christmas Day is something of a surprise — a rate hike is not normally
on the wish-list for Santa Claus, but in China’s case this is a prudent
move,” said Brian Jackson, economist with Royal Bank of Canada in Hong
Kong.

“We think it is increasingly clear that using quantitative measures,
such as reserve ratios, to rein in liquidity and credit has not been
enough, and that adjusting the price of credit — that is, interest
rates — is needed to get price pressures under control.”

While China can handle a slowing down of its economy, can it actually
handle the types of actions necessary to both reign in growth, while
killing inflationary reality, and still growing at a rate to obsorb the
jobless in China?

I personally don’t expect that they do. A command economy is great
for getting projects started, it is not so good at slowing down a run
away train. There are to many people who are still on the old play
book, or have fully committed to generating the growth that can not
survive the slow down effect.

It is always easier to go “All In”, then it is to get “all out” and
still keep your risk capital. This is the issue Chinese governments
below the central planners now have to deal with. In a few years, the
cost of allowing the misallocation of capital to grow to the level it
has, is going to impact the long term stability of China Inc.

This is basic capital allocation issues, and obviously China has
expanded its economy year over year, until these aspects have been
given a chance to get fully ingrained. The black swan of China is when
it cant service its internal loan portfolios due to lack of cash flow
and lack of new capital to leverage up, with a slow down in demand for
products.

Every growth economy has hit this wall. The US in the 1930′s, the
Japanese in the late 80′s to early 90′s when a square foot of property
in Tokyo was worth $1 million US dollars or some silly quote. The case I
am remembering was a sushi shop with 32 sq ft of space and a price tag
that should make a professional blush.

Boom Bubble Bust always pop. Its just a matter of when, and what
happens after that. China appears to be doing what it has to to slow
down, I am not sure they grasp how hard it will be to both slow down and
maintain growth.

Jack H Barnes was named the audited Top Stock Picker in 2005
by Forbes’s “Best
of the Web”. He is a retired hedge
fund manager. He now writes about Global
Macro Economic issues at jackhbarnes.com.
His twitter feed can be reached here.

Disclosure: Long Popcorn

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Sun, 12/26/2010 - 12:34 | 830462 TexDenim

"verses waiting until the start of the new year" does he mean "versus"? "to both reign in growth" does he mean "rein in growth"?

Who is this clown? Sloppy writing is almost always a sign of sloppy thinking. If this bozo can't spell simple English word, his thinking probably is deeply flawed.

Sun, 12/26/2010 - 12:20 | 830456 markar