My first post was effective in its brevity but cut short many key points that provide context for the blog. I think it is intuitive to address some of these points before diving into some granular data.

 

Debt Information

In my first post, I alluded to growth of news from China; It is a great thing. Sadly, the quantity of news does not correspond with a growth in quality.  However it is worth noting that Michael Pettis, Christopher Balding, Paul Gillis, and Bill Bishop run amazing blogs that provide a wealth of information specifically about China.  I would like to address the recent economic downturn to provide context to later posts. and as a counter to more main stream reading.

If you read this article, one would be confused as to the causality of PPI, debt, cashflow, and other often quoted metrics.

I am going to address the history that is given in this article at later date for fear of turning this post into a small book. Instead, we will examine the key points:

The world could no longer absorb the added supply of Chinese goods. Exports plunged, prices declined, leaving local communities stuck with idle factories and saddled with debt, most owed to government-owned banks—some have a portion of their shares listed in the Shanghai Exchange.

China’s miracle policy, which made its leaders look smart, began to look more like a mirage, threatening the economic future of the country and the world economy.

Financial markets have just begun to take notice.

The world was forced to pay for added supply funded by Chinese savers and consumers. China, as the author addresses, did not have a miracle. It took money from savers and consumers to finance state directed investment. If I wrote this article, my final sentence would read, “Financial markets have known this all along, as evidenced from last year’s plunge and the freakish lack of growth prior to the Chinese government pumping hundreds of billions of dollars into equities, but the aforementioned billions create a tension that we are now witnessing.”

I digress. The real point here is that what Mr. Panos Mourdoukoutas identifies at the beginning, PPI linking to equities, is only touching the point he ends on, debt.  A rise in debt burdens is fueling speculation and capital flight, devaluing the currency and hurting equities.  Examining PPI can be useful but one should start at the debt burden and how it is becoming more difficult to service the debt.  Producers, financed by savers, have certainly had a rise in costs, but China’s issue of debt and debt servicing is more complex.

Let’s first acknowledge PPI by looking at information from Ecstrat .

As a completely unrelated note, please notice the trend in real estate.

GICS Industry Group	Capex/          Capex/        Change    Revenue   Capex     Sales           Sales              in         Growth   Growth      2014            2010            Capex
Utilities	26.3%	35.4%	-9.1%	59.1%	18.1%
Semiconductors & Semiconductor Equipment	19.3%	25.6%	-6.3%	34.7%	1.5%
Consumer Services	7.1%	12.5%	-5.4%	87.8%	6.1%
Transportation	11.6%	15.4%	-3.8%	49.6%	12.4%
Media	8.8%	11.7%	-2.9%	94.7%	47.0%
Software & Services	6.8%	9.7%	-2.8%	195.2%-108.4%
Technology Hardware & Equipment	6.5%	9.0%	-2.5%	96.9%	42.4%
Materials	7.5%	9.6%	-2.1%	48.0%	16.3%
Household & Personal Products	5.7%	7.5%	-1.8%	69.0%	27.9%
Consumer Durables & Apparel	4.3%	5.6%	-1.3%	60.6%	24.1%
Capital Goods	3.5%	4.7%	-1.2%	55.3%	16.7%
Health Care Equipment & Services	2.0%	3.0%	-1.0%	161.2%	73.2%
Food Beverage & Tobacco	8.0%	9.0%	-1.0%	68.7%	50.4%
Automobiles & Components	4.9%	5.8%	-0.9%	55.2%	31.6%
Pharmaceuticals, Biotechnology & Life Sciences	8.7%	9.2%	-0.5%	97.4%	86.4%
Retailing	4.5%	4.9%	-0.4%	78.7%	65.4%
Food & Staples Retailing	4.7%	4.8%	-0.2%	64.5%	59.1%
Energy	16.4%	16.5%	-0.1%	55.1%	54.2%
Real Estate	6.7%	6.6%	0.2%	139.9%-146.4%
Commercial & Professional Services	8.6%	8.3%	0.2%	140.0%-146.5%
Telecommunication Services	5.0%	2.7%	2.3%	88.0%-244.2%
Grand Total	6.9%	8.7%	-1.8%	64.7%-30.6%

Many companies are decreasing capital expenditure in a sign of over investment, but many companies are increasingly taking a hit from revenue and financing. Cash flow growth for many industries are being squeezed.

When looking at Chinese debt and debt servicing, one needs to know how over invested a company is – changes in capital expenditure being a good measure, what entity will provide financial relief (how financial relief happens is interesting but famously foggy), and changes in cash flow.

Rising PPI is interesting within proper context of overall Chinese debt dynamics.

Ideology

China is now faced with a choice. It can adopt the market driven reform it has alluded to but since avoided, or China can use more capital to fund failing companies, making the economy worse. Market reform is touted but has yet to be implemented, and with the equity market failing, I cannot see what the party leadership is waiting for. Why is communication with the markets so difficult, and why is there such a wait for the reform that is officially the party line?

Deng Xiaoping, in his famous 1992 southern tour, called for greater opening and scope of reform. Reform was aimed at smoothing State Owned Entity operation and alleviating a rising debt burden.  Before 1992 not a single SOE was privatized. The Fifteenth Party Congress in 1997 announced the next big step, “grasping the big and letting go of the small.” Large SOEs were to be restructured and small SOEs, which the State Development and Planning Commission (1998) estimated to be 18 percent of state assets, were to be privatized. Clear signs that the government wanted to move away from the most competitive sectors of the economy were met with straightforward sales and mergers. This transition requires attention, and it’s implementation shouldn’t be taken lightly. Yingyi Qian (1999) commented, “It is quite remarkable for China to overcome ideological and political opposition to embrace the market system and private ownership without a political revolution.”

The Third Plenum of the 18th Party Congress issued equally great ideology. Published in January 2014, ‘the decision’ document gave reform ideology and a timetable. The documents given timetable of 2020 for policy implementation is far from legally binding, however anything published by the CCP that details reform headed by Xi Jinping is important to understand. There are two key economic points that give context to this blog:

1.) Markets are to play a decisive role in resource allocation. The language of ‘settling’ the relationship is of the utmost importance.

2.) Interest rate and capital market liberalization

 

It’s all about perspective

 

As news of China’s economic slowdown continues to grow in standard media, I feel it is important to provide high quality information about how policy implementation looks. This blog hopes to connect large macro-economic Chinese ideology to micro economic realities.

On November 26th the FT quoted Goldman Sachs as estimating China had spent $236 billion in support of the stock market, signaling a divergence from the market driven resource allocation as previously outlined.  There is an obvious need to look at ideology versus implementation as the Xi administration enacts policy in such a different way from his predecessors as highlighted at the beginning of this post.  This blog will give a bottom-up perspective on China, particularly Chinese investment vehicles.

I look forward to regular posts and providing the highest quality content I can. Thank you for reading.