Monday, July 20, 2009

Morgan Stanley Sees Bubbly China

and it's just fine and dandy with them.

Their latest on the Global Economic Forum is "Policy-Driven Decoupling: Upgrading Our 2009-10 Outlook", July 17, 2009 by Qing Wang, Denise Yam, CFA & Steven Zhang , Hong Kong.

"The Chinese economy staged a stronger-than-expected rebound in 2Q09, with real growth reaching 7.9%Y, up from the trough of 6.1% in 1Q09. On a seasonally adjusted basis, we estimate that the economy grew by a strong 4.5%Q (+19% annualized), accelerating from 1.5% in 1Q09 and the trough of 0.4% in 4Q08. We attribute the better-than-expected economic performance to the maintenance of the growth-boosting policy stance, which made possible a much-accelerated realization of the real stimulative effect from the multi-trillion renminbi fiscal package and expansionary monetary and credit policy, which we originally expected to materialize only in 2H09. In particular, policy-driven monetary and credit expansion, which has been consistently surprising on the upside, has enabled the significant pick-up in domestic investment. The Rmb1.53 trillion new loans made in June sent money and loan growth to new record-highs of 28.5%Y (M2) and 34.4%Y, respectively. Credit creation in 1H09 totaled Rmb7.37 trillion, three times the amount in the year-ago period, and exceeding the 2008 total (Rmb4.91 trillion) by 50%, helping to finance the 35.7%Y growth in fixed asset investment (nationwide) in 2Q09, up from 28.8% in 1Q (33.5% in 1H)."

So the Morgan Stanley analysts are basically saying that the Chinese stimulus is working miracles, unlike those in the Western nations. So where is this "domestic", "fixed asset" investment going, which is the result of "policy-driven monetary and credit expansion"?

Their summary does mention "the strong recovery in property sector", but the detailed discussion oddly starts with domestic consumer consumption (which the analysts say resilient) offsetting external weakness (i.e. export). I take it to mean it has stopped going down. Export has cratered because the U.S. and Europe are not buying anytime soon.

Then they talk about "policy-driven decoupling", meaning China has forced the banks to lend by lowering the interest on the reserves (they don't mention this) so the market is awash with new credits looking for places to go. And they are going places.

"Specifically, sustained and stronger-than-expected credit growth in recent months has continued to buoy sentiment and helped to deliver: a) an accelerated rollout of public infrastructure projects; b) more resilience in private consumption and private manufacturing sector capex despite weak exports; and c) an increasingly convincing recovery in property investment. These positive developments, together with the steady asset price reflation, are serving to compensate for the prolonged weakness in external demand."

The newly created money is going to public infra projects (not the most efficient use of money in any country, particularly in China), private manufaturing sector capital expenditure (without demand from export, that means overcapacity being built), and property investment. The money apparently make Chinese citizens feel good, as an important side effect.

The Morgan Stanley analysts call these developments "positive", and happy to see "the steady asset price reflation". It's the bubble time again!

Didn't we just popped one gigantic bubble based on asset price inflation? And these analysts are hailing the reflation of the same bubble and misallocation of capital?

They also say that despite rapid increase in M2 (28.5%), there is no need to worry about inflation at least for the next 12 months. And yet they talk about steady asset price reflation. So if I try my best to understand the Morgan Stanley economists, China is in a wonderful situation:

  • The stimulus is working, thanks to the government's monetary and economic policies, and money is going to infra, capacity build-up, and real estate market (wonder why they don't mention stock market);
  • Chinese citizens are happy that the asset price is being reflated without food price going up;
  • Export will resume its growth in the 4th quarter because of renminbi's peg to the weakening U.S. dollar and because of tepid demand to be coming from the U.S. and Europe;
  • M2 is growing rapidly but there will be no price inflation for at least for 12 months even if asset prices are reflating.
That foreign hot money is back in China I have little doubt. China's purchase of U.S. Treasuries jumped in May by $38 billion. China's central bank has been busy absorbing the U.S. dollar that has been entering their country; their foreign reserve recently topped $2 trillion.

I can't picture a worse scenario than to have a central planning and have a flood of hot money coming in.

Morgan Stanley recently announced that it plans to repackage a downgraded collateralized debt obligation backed by leveraged loans into new securities with AAA ratings. The firm seems to want the return of good old bubble, so it's little wonder it is cheering the new (old) bubble in China.


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