It's one thing for China to have a rather embarrassing episode during a boat launch, or even when demonstrating the pride of its airforce. But when a part of the Great Wall Of China itself collapses, literally, you know the proponents of the Chinese Soft-Landing scenario (leaving aside that copper is now down 10% for the week) may want to reassess their thesis. From China Daily, "The damaged portion of the Great Wall is located in a remote area near the county of Laiyuan in Hebei Province, about 200 kilometers southwest of Beijing. The area is home to a dozen small mines, with some operating as close as 100 meters to the centuries-old wall. Villagers and local cultural heritage protection officials told Xinhua that about 700 meters of the wall, which was built during the reign of Emperor Wanli during the Ming Dynasty (1573-1620), had already collapsed, and more walls and even towers are likely to collapse if the mining continues unchecked." And while this is admittedly a symbolic development, we follow up this news with a piece from SocGen's Albert Edwards who has some quite factual observations on why China is now in stall speed and has little hope of a Hollywood ending.
But first, more on this highly ironic development, which confirms just how little control over its economy the central government really has:
Zhou Jinjun, a deputy head of Laiyuan's land resources bureau, said the area where the ancient walls stand in Laiyuan has rich reserves of copper, iron, and nickel. Driven by profits, small mines proliferated despite the government ban.
A part of the Great Wall in Hebei's Chongli County was even demolished by a mining company to make way for road construction.
Zhou said law enforcement officials have found it difficult to completely stamp out small mines as mine bosses are armed with advanced communication equipment, helping them dodge law enforcement.
The State Council enacted a regulation to protect the Great Wall in 2006, banning people from taking soil or bricks from the wall, planting trees, carving on the wall or building anything that does not protect it. But experts and cultural heritage officials said the bans are poorly enforced in remote regions.
Guo said miners in Laiyuan did not knock down the walls, but mining at such a close range to the walls poses more serious threats.
And in more serious news, here is SocGen's Albert Edwards with a recap of his recurring opinion that China is due for a crunch of epic proportions:
Regular readers will know that I have a reasonable track record with the big calls over the years. All these calls had one thing in common. The markets got intoxicated with a good "growth" story that, with the benefit of rampant credit growth, became a full blown bubble.
And so it is with China. We listed recently the financial market historian, Edward Chancellor's 10 key facets of a financial bubble (see GSW, 24 June). After the US credit debacle, I find it perplexing that Chancellor's Rule 2 is so relevant for China - namely “A blind faith in the competence of the authorities”, in this case in their ability to soft-land the economy. For myself I cannot understand this confidence. A soft landing may indeed be the outcome, but it's unlikely. China is undoubtedly a severely imbalanced economy, suffering from creditfuelled investment and housing excesses that could easily spin out of control and crash, just like all the other "highly regarded" economic bubbles before it.
Our China economist Wei Yao believes the authorities are targeting a decline in property prices of 5-10% to appease this discontent. And she notes that, in September, the implied deflator for national residential housing sales rose a meagre 0.5% yoy. Wei also notes that the City of Wenzhou seems to be acting as a leading indicator as property prices have already started to decline by 0.5% yoy (see right-hand chart above, incidentally I have been impressed with quality and clarity of Wei's analysis on China and comments on data. If you want me to put you on her list, just drop me an e-mail).
And therein lies the rub. If the authorities are trying to deflate property prices, why won't this cause the overall economy to crash, just as it did in the US? The answer is that it can and probably will. But I am sitting in my kitchen writing this with every single work surface covered in persuasive articles about why the economy will soft-land. Some economists are so reassuring. Even in 2006/7 when I was convinced disaster was around the corner I often found
their calm siren stories disturbingly reassuring.
The ironic thing, which virtually invalidates any economic data out of China, is a statistical representation which mocks the lack of volatility of an economy which is booming at an unprecedented pace:
China is a "freak" economy. To my knowledge no other economy in history has experienced such high investment/GDP ratios and seen so many sequential years of strong investment growth (see chart below). If you came down from Mars and saw an economy with an investment/GDP ratio of 50% you would conclude it would be among the most volatile in the world, not the most stable!
Albert proceeds to discuss last night's news of a major drop off in FX reserves:
There is one additional phase to the China credit crunch which recently arrived at the party (or wake). Foreign exchange reserves have stopped rising. They grew by a paltry $4bn in Q3 compared to an average monthly rise of $58bn in the first half (see chart below).
Why did China FX reserves growth stall in Q3? Many suggest capital flight may have occurred recently, but also the recent buoyancy of the dollar would have played a role, as less FX intervention by the PBoC will be needed to peg the exchange rate. We have been strong in our belief that growth in global foreign exchange reserves has been closely associated with buoyant EM equity and commodity markets. We have shown previously that the dollar's rally in mid-2008 and the collapse in the growth of China's FX reserves preceeded the collapse in commodity prices and EM equities in 2008 H2.
Obviously this goes back to a favorite theme of Albert's: the fact that China has to devalue the Yuan eventually. Sure enough, in the footsteps of Brazil's 2nd rate cut in 2 months, even China appears to be sending a loosening signal: last night the PBoC lowered the yield on 3 year bills for the first time in 15 months. Baby steps, yes, and next come RRR reductions, and so on, ultimately culminating with Edwards' prediction.
Yet it is his conclusion from today's piece that bears most attention:
Amid the growing risk of a trade war, one thing is clear: Chinese authorities are trying to softland a credit-fueled property/investment bubble. They may succeed at their own bit of cankicking,but history is not on their side. The sudden cessation of FX reserve growth (China's very own form of QE - see chart below) may well be the last straw to break the panda's back. And if China is hard landing, I agree with the bulls on one thing: expect the authorities to become aggressively stimulative. And if as is highly likely, aggressive conventional monetary and fiscal stimului fail to prevent a hard landing (as indeed was the case in the US in 2008) - "other" measures will surely include yuan devaluation.
This chart should be familiar to regular readers - it was a few short days ago that we presented the comparison of China's M2 and the SHCOMP, which led us to the same conclusion:
China M2 Change...
And M2 vs SHCOMP YoY change.
It remains to be seen how long until the SocGen strategist is proven right. In the meantime, expect far more pain for the symbol that once separated China from the evil outside world. Alas, if the decoupling thesis is about to break (once again) then the continued deterioration of the Great Wall will have that much more of a inherent symbolism.