Who can blame investors for being skittish during times of economic turmoil. Lately they have seen stock market volatility swings of hundreds of points within a single day, and financial entities like Bear Stearns, Lehman Brothers and Washington mutual dissolve. Such chaos can make it difficult to stay focused. 

The United States’ financial system breakdown has been an enormous cause of the change. Not only has the Stock Market seen devastating losses, but the U.S. economy has fallen into a deep depression which may be for an extended period of time. The last time the U.S. housing market had this many pending foreclosures was during the Great Depression. Worldwide markets have followed the U.S. in its spiraling downturn.

It’s a small wonder that head of China’s sovereign wealth fund says he has lost the confidence to invest any part of his nation’s mountain of foreign reserves in U.S. banks. As he put it, he didn’t have the courage to invest in the U.S.

BANKING ON CHINA

It was just a short time ago when China’s banks and its infant stock market were not taken seriously. How have the times changed. China’s banks can now look down from their seat of strength on their western counterparts.

Louis Kuijs of the World Bank office in Beijing remarked, “We feel China’s financial system and its banks are, in relation to the chaos in the U.S. and other parts of the world, relatively shielded from those problems.”  Kuijs’ comments on China’s exposure to the global financial crisis are kind. Shielded in an understatement.

ICBC, Industrial and Commercial Bank, China’s largest commercial bank did hold $151 million of of Lehman Brothers, half a billion dollars in collateralized debt obligations, $1.9 billion in structured investment vehicles. ICBC, practically wrote them off, stating that they were near-worthless and only represented 0.55% of ICBC’s total assets. The bank has relatively few bad mortgages since Chinese borrowers are required to put down up tp 40% on real estate purchases. Third quarter ICBC profits were up by 25.5%.

As China’s Premier, Wen Jiabao explains, “The financial system is sound and safe…we have full confidence in China’s economic development and financial stability.” Chinese financial institutions have great risk management and have grown stronger during this global financial crisis.

AMERICA’S BANKER

During China’s thirty-year economic explosion, they have managed to mass the largest foreign reserves the world has ever seen. With a mountain of over two trillion dollars in foreign reserves, China has the resources to maintain its internal economic growth despite the slowing of exports to other countries. The economic stimulus package announced in November, earmarked part of the $586 billion dollars to infrastructure development. This mountain of cash gives China’s leadership a sense of security to avoid the economic chaos of the rest of the world.

Even more important to the United States is the fact that China has now officially taken over the number one spot as America’s banker.

As the graph shows, China’s holding of U.S. debt has steadily increased over the past several years. According to U.S. treasury records, China has passed Japan as the largest foreign buyer of U.S. Treasuries of $585 billing, and it is steadily increasing. The Chinese government realize that they hold most of the cards in the U.S. - China financial relationship.

In 2006, U.S. Treasury Secretary Henry Paulson began to fly to Beijing periodically to “teach” the Chinese the proper way to run their economy and stock exchanges. Paulson explained that the Chinese were failing to grow and secure its nation’s stock exchanges due to the hesitation to embrace derivatives. Again, how times have changed. Paulson found himself as the student in a recent visit to China. Central Bank Governor Zhou Xiaochuan told Paulson that the U.S. need to begin to take account for its huge trade and fiscal debts. Americans should be more like the Chinese and begin saving more and rely less on credit. America’s financial problems stem from over-consumption. A blunt remark by China’s Vice Premier, Wu Yi which some think of as a threat, he said that America should, “take all necessary measures to stabilize its economy and the financial market to ensure the security of China’s assets and investments in the U.S.”

Vice Premier Wu is warning us that China might stop financing U.S. debt and stop investing in America. As the saying goes, “He who pays the piper calls the tune.” For the first time, Beijing is calling the tune for America and telling us to get our financial act together or else.

IS CHINA IMMUNE TO THE GLOBAL CRISIS?

Since China relies heavily on exports, the Chinese economy is beginning to feel the effect of the worldwide financial crisis. Some major factories have closed leading to employee demonstrations. China’s GDP growth is slowing, and financial news outlets are reminding the Chinese people that exports are declining. But how serious will the effects be?

To understand China’s economic growth, you must look at real data. Financial news headlines and the media state that China’s exports are declining. But are they? Not at all. As you’ll see in the graph below, both China’s exports and imports have been increasing steadily except for the month of February when a freak blizzard shut down much of China’s economic heartland.

The rate of export growth is what is slowing due to western economies slowing.  China’s actual export growth rate was up 19.2% in October of 2008, the latest statistic at this writing. What needs to be reported is that China’s economy is showing incredible resilience in the midst of worldwide recession. China’s trade surplus jumped an incredible 20% in September of 2008. Part of the reason for China’s increasing trade surplus is a relative decline in imports to the Chinese mainland. Any further weakness in China’s economy will be reflected by a drop in demand for imports, a trend that once again puts China in the driver’s seat.

China’s exports are not the true life blood of their economic growth. Chinese economist state that exports only account for a quarter of the nation’s total economic activity.

Zhou Shijian, a senior researcher at Tsinghua University, recently told China Business News that Chinese enterprises were able to overcome weak overseas demand because China’s exported products are mostly “daily necessities with low elasticity of demand.” Demand from emerging markets remains strong, and Beijing is increasing tax rebates to keep China’s products competitive in less developed countries.

CHINA’S STOCK MARKET CRASH?

The Shanghai Stock Market has fallen almost 70% from its all time high of 2007. The Shanghai Stock Exchange (SSE) did begin its slump prior to the decline of the western stock markets. That’s because stocks listed in Shanghai were grotesquely overvalued by any standard measure such as P/E ratios as China was caught up in a retail investor bubble. The SSE has since corrected itself and stock are no longer overvalued. Reports of Chinese companies with double digit growth has not yet been reflected in their stock prices. Galaxy Securities of Beijing says the average price earning multiple for stocks traded on the Shanghai Exchange is now 16.02. Valuations of Chinese ADRs are also at a low due to intense volatility on U.S. stock exchanges.

Galaxy also reports that earning are anticipated to grow by 7% in 2009, and 15% in 2010. Cash rich Chinese companies are looking to buy up foreign assets.

• China Life, the world’s biggest insurer by market value, says it wants to buy parts of AIG.
• PetroChina, Asia’s biggest oil and gas producer, says it may buy some overseas companies badly hurt by the global financial crisis.
• Industrial & Commercial Bank, China’s largest commercial bank, says it aims to double its assets outside China within three years.

THE TIPPING POINT

China’s contributions to world economic growth are now comparable to those of the United States according to UN Under-Secretary-General Sha Zukang. The most resounding declaration of China’s growing importance comes from the International Monetary Fund’s chief economist, Olivier Blanchard who says one hundred percent of global economic growth will come from emerging economies including China. As the world’s biggest emerging economy, China is central to that process.

As IMF economist Blanchard told an Italian newspaper, “There will be a shift in power. China will emerge from these events in a stronger position.”

China is not yet the world’s largest economy, but China’s influence is starting to challenge the global dominance of the United States.

By Jim Trippon
Editor-in-Chief
China Stock Digest
Http://www.chinastockdigest.com

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