China Retail Rose by 22% - Decoupling or not?

Retail in China rose by 22%. Good news. A solid proof of decoupling, isn't it?

Wait. Question: By what percentage the wages has increased in China since last year?

20% at least. Middle management and professionals have even higher percentage as shortage is there.

But do we still have shortage this year? Or has the gap been narrowing? According to my little survey on headhunters, the answer is "YES', particularly on real-estate, finance, investment, and professional services related areas. These people belong to one of the groups who can spend most.

The decline of sales on telecommunication and electrical appliances and household related decorative and utilities materials, another part of the domestic consumption, which takes a big pie on manufacturing, tells another story. The decline on real-estates and investment has already started to affect on certain area. Another area that was not told in the statistics is restaurant. The middle-to-high class dining places have been closing ever since the lower half of the year.

Clothing rose. But please pay attention that the real famous brand name fashion companies all have significant loss, including China areas, in their income statements. Daily casual clothing is not much affected: afterall, you will not go naked on the street, aren't you?

One should never forget that the largest pie on GDP is still export. Yet, influence on the consumption due to weakening export takes time to effect. It has to walk through the supply chain, shut down the factories that solely rely on exports, laid off their labour, cause the remaining to focus on domestic market, initiate another round of survivors' games, kick out the unfit, cause another lay-off wave, cripple some stores, layoff the labour related to that sector, and eventually settle.

Won't the 4t RMB stimuli program bail China out from this miserable future? Government spending project can certainly prevent or at least delay the worsening. But it cannot simply reverse the trend and boost China economy to a new level. For details, please refer to my previous articles.

Afterall, this year China workers have salary risen. How about next year?

AAA drops; TED Spread Rises

Both 5 year and 10 year AAA banking and finance rates drop at a slower speed, and settle at 6.30% and 7.77% respectively. The risk premium of each is 530pts and 677pts respectively. One month prior, immediately after Oct 10 and interest rate cut by 50pts, the risk premium of each is 475pts and 600pts respectively. With massive bailout and expectation on new policies, banks are still unwilling to do longer term commercial loans. The figures are actually worsening. More bankrupcies in USA can be expected (that will further drive down the market).

Mortgage rates drop also slowdown and settle at the range of 5.93 to 7.31%. Property market will continue to go worse and trigger another wave of panic.

1 Month LIBOR is 1.54%. 3 month LIBOR is 2.24%.

The 3-month T-bill was auctioned yesterday at a discount of 0.355%. Today at ET2:00am the T-bill was quoted at the discount of 0.42%. Despite the drop which may be a hint of capital leaving risk-free market looking for short-term return, the TED remains at 182pts, some 150pts deviated from the normal range. Further observation on the 3-month T-bill at later period, after Asian market closing and European marketing opening, may show the trend of US market tonight.

Meanwhile, UK, Japan, Germany, and Australia have their government bond prices risen. Investors on OECD are shown to become more and more risk-adverse. Brazil bond prices dropped on the other hand. Lack of confidence on emerging countries economic and underlying political stability arises. Money continuously flows out from these countries.

Hong Kong, with the rather small pool, China factors, free capital flow, and lame government becomes a haven for speculators and risk-takers. By balancing a portfolio with risk-free assets, globalized investors can on the one hand borrow JPY to invest on comparatively safer asset in OECD countries; on the other hand, can put a part of the investment to make a fortune by speculating in Hong Kong. While overall speaking Hong Kong will not be immuned from the downturn by both USA and China, high magnitude of fluctuation on a downward long-term curve can be expected.

Money Supply Drop on the Last Week of Oct

According to bloomberg, the M2 supply was recorded as -48.2billion at the last week of October, 2008.

Meanwhile, the secondary market 13wk (3month) T-bill yield at the same week were as follows:
Oct 27 - 31: 0.84, 0.76, 0.61, 0.40, 0.44

Despite the fact that the target rate was dropped from 1.5% to 1.0% at the same week, the drop on yield is still significant. We may compare with the same data for one week earlier.
Oct 20 - 24: 1.24, 1.09, 1.03, 0.96, 0.86
M2: 54.3b

It may be a coincedence. However, if US government becomes competitive with the bank on taking deposit, the efforts of US government on money injection to the banking system will go in vain.

Long-term AAA banking and finance rate premium over target rate maintains high:
5 year: 542pts;
10 year: 687pts

So are mortgage rates:
30 year fixed: 503pts;
15 year fixed: 470pts;
5/1 year ARM: 495pts;
1 year ARM: 469pts

Both corporate and property loan markets signal winter. Government bonds are welcomed despite its low yield rate (and even lowering coupon rate). Particularly under the expectation on further reduction on FED target rate will bring up the government bills, notes, and bonds prices. Goverment's abilities on fund raising is also weakened due to lack of creditibility in spite of the announced result of presidential election. Currency of USD will be expected to drop against EURO this week, neutral against JPY, and rise against AUD, NZD, etc.

China's 10 economic stimuli may have some encouargement on AUD rate. Yet, the declining economy plus the sliding interest rate will offset the favorable factors and further turn AUD downward.

This week USA equity market may also experience another slide (with fluctuation), with the knowledge that money is looking for shelter from volatility and grimmy hope. The rebound within this week may prove technical only.

Chinese Bonds may Surge

The massive stimuli plan requires fund to operate. With the reduction of export and the growth of foreign currency reserve, Chinese government cannot print as much money as last year. While rising RMB rate is a method, the side-effect of further hammering the already-at-stake manufacturing industry is too much to risk of. Even though the isolation from many of the foreign financial products prevents massive write-offs, banks in China will still be prudent on loans due to the reduction of risk premium by interest rate cut. Therefore, a plausible plan for Chinese government is to issue bonds at a low price and a high yield to collect money from the public. With the expectation that further interest rate cut may follow, the bond price has the potential to rise. It can be furthered by the rather lack of choices on financial products.

Nevertheless, it will enlarge the financial deficit of Chinese government and may act as a disfavorable factor on the future RMB rate.

The 10 Saving Measures of China

From New China Agency:

温家宝主持召开国务院常务会议 研究部署进一步扩大内需促进经济平稳较快增长的措施

新华网北京１１月９日电
国务院总理温家宝５日主持召开国务院常务会议，研究部署进一步扩大内需促进经济平稳较快增长的措施。
会议认为，近两个月来，世界经济金融危机日趋严峻，为抵御国际经济环境对我国的不利影响，必须采取灵活审慎的宏观经济政策，以应对复杂多变的形势。当前要实行积极的财政政策和适度宽松的货币政策，出台更加有力的扩大国内需求措施，加快民生工程、基础设施、生态环境建设和灾后重建，提高城乡居民特别是低收入群体的收入水平，促进经济平稳较快增长。
会议确定了当前进一步扩大内需、促进经济增长的十项措施。

一是加快建设保障性安居工程。加大对廉租住房建设支持力度，加快棚户区改造，实施游牧民定居工程，扩大农村危房改造试点。

二是加快农村基础设施建设。加大农村沼气、饮水安全工程和农村公路建设力度，完善农村电网，加快南水北调等重大水利工程建设和病险水库除险加固，加强大型灌区节水改造。加大扶贫开发力度。

三是加快铁路、公路和机场等重大基础设施建设。重点建设一批客运专线、煤运通道项目和西部干线铁路，完善高速公路网，安排中西部干线机场和支线机场建设，加快城市电网改造。

四是加快医疗卫生、文化教育事业发展。加强基层医疗卫生服务体系建设，加快中西部农村初中校舍改造，推进中西部地区特殊教育学校和乡镇综合文化站建设。

五是加强生态环境建设。加快城镇污水、垃圾处理设施建设和重点流域水污染防治，加强重点防护林和天然林资源保护工程建设，支持重点节能减排工程建设。

六是加快自主创新和结构调整。支持高技术产业化建设和产业技术进步，支持服务业发展。

七是加快地震灾区灾后重建各项工作。

八是提高城乡居民收入。提高明年粮食最低收购价格，提高农资综合直补、良种补贴、农机具补贴等标准，增加农民收入。提高低收入群体等社保对象待遇水平，增加城市和农村低保补助，继续提高企业退休人员基本养老金水平和优抚对象生活补助标准。

九是在全国所有地区、所有行业全面实施增值税转型改革，鼓励企业技术改造，减轻企业负担１２００亿元。

十是加大金融对经济增长的支持力度。取消对商业银行的信贷规模限制，合理扩大信贷规模，加大对重点工程、“三农”、中小企业和技术改造、兼并重组的信贷支持，有针对性地培育和巩固消费信贷增长点。

初步匡算，实施上述工程建设，到２０１０年底约需投资４万亿元。为加快建设进度，会议决定，今年四季度先增加安排中央投资１０００亿元，明年灾后重建基金提前安排２００亿元，带动地方和社会投资，总规模达到４０００亿元。
会议要求，扩大投资出手要快，出拳要重，措施要准，工作要实。要突出重点，认真选择，加强管理，提高质量和效益。要优先考虑已有规划的项目，加大支持力度，加快工程进度，同时抓紧启动一批新的建设项目，办成一些群众期盼、对国民经济长远发展关系重大的大事。坚持既有利于促进经济增长，又有利于推动结构调整；既有利于拉动当前经济增长，又有利于增强经济发展后劲；既有效扩大投资，又积极拉动消费。要把促进增长和深化改革更好地结合起来，在国家宏观调控下充分发挥市场对资源的配置作用；发挥中央和地方两个积极性。
会议强调，尽管我们面临不少困难，但我国内部需求的潜力巨大，金融体系总体稳健，企业应对市场变化的意识和能力较强，世界经济调整为我国加快结构升级、引进国外先进技术和人才等带来新的机遇。只要我们及时果断采取正确的政策措施，把握机遇，应对挑战，就一定能够保持经济平稳较快发展。

In appearance the plan looks grand. However, plan 7 has to be done no matter under what circumstances. Plan 2 and 8 target on improving securities to town's residents and farmers for narrowing the income gap and stablizing these people. They are more political than economical. So is plan 1 for the root class in big cities. Plan 4 is for social welfare purpose and hence political stability. Plan 6 is vague; it is more than obvious that Central Government has no ideas on how to do with high tech development.

On the other hand, plan 3 has already been launched before the financial turmoil. And as they are large scale infra-structural projects, they cannot be speeded up at will. More money may put to raise more projects and create more opportunities. Although these projects can improve the hardware economic efficiency and effectiveness of the country, the main aim is more on creating jobs to prevent citizens from going mad and riot due to unemployment. Plan 1, 2, and 5 have similar properties. The Net Present Values of these projects are on questions.

The more substantial plan is plan 9 which can help ease the real core deal: the closing of production facilities due to liquidity and heavy taxation. Nevertheless, even if they can pass over the toughest liquidity period, whether or not they can stand a chance in 2-3 year period of time is subject to queries. Afterall, the GDP drops due to OECD economic recession is too large for domestic consumption to offset. Plan 10 can work with plan 9 to provide bandages to the current doomed manufacturing industry.

Nonetheless, for the manufacturing industry, even with such a large scale of bailout plan, they may not be really able to survive. We can perform a simple calculation as below:

For simplicity, and as according to recent roundup GDP figures (in USD): US GDP is 12t; EU is another 12t; Japan is 4.5t; Total = 12t + 12t + 4.5t = 28.5t.

GDP by consumption takes about 70% of total GDP; so it is 28.5t x 70% = 19.6t.

Assume in the following year the OECD will experience a drop of 2% on total GDP; evenly distributed to every sector, thus, the drop of GDP on OECD consumption will be 19.6t x 2% = 0.392t.

Now, China's Total GDP is 2.4t, with 39% on export = 0.936t. Assume China export only take 40% of the pie of the consumption GDP of OECD countries. Thus, the drop of consumption GDP of OECD countries that will affect China will be 0.392t x 40% = 0.1568t. It means a reduction of 0.1568/0.936 = 0.1675 or 16.75% of export GDP of China. It is a lot.

As China's domestic consumption GDP is 40% of total GDP, i.e. 2.4t x 40% = 0.96t. In order for the domestic consumption to completely take over the decline of the pie on export manufacturing it will be an increase of domestic consumption by 0.1568/0.96 = 0.1633 or 16.33% .

Take another point of view. There are about 400m citizens living in the big cities that are the core consumption force. To spread the increase of 0.1568t to 400m people, it means 156,800m/400m = 392USD/year additional consumption. With the average annual income at 2000USD, it means they need to have a minimum increase of after-tax salary by 392/2000 = 0.196 or 19.6% next year in order to completely offset the lost of GDP from overseas. Under the current economic environment, how can it be done?

A New Era

But it is not defined by Obama.

It is defined by the financial tsunami. It is defined by the de-leveraging. It is defined by the return to invest on values, not on derivatives.

Different countries have risen to power at different periods. Besides their power, the economic shift brought by these countries exert its influence on their own citizens and then project to the world. The new value becomes universal, and everyone in the world is willing to pay for it. Money funnel to those countries and propel their growth.

UK - Industrial Revolution -> improved efficiency and throughput and division of labour.

Germany - 2nd Industrial Revolution -> electricity prevails and further enhances not only efficiency and throughput but also the decreased size (and interference).

USA - Booming of invention -> self-propelling steamboat; automobile; aircraft; light bulbs; recorders; radio; microwaves; TV; telephone; rockets; satellite; fax; computer; internet.

Japan - do what USA can do, and only better and cheaper, except a lack of advance on high tech like computer and internet.

Whenever a new product (and its adhered value, life style, production and management models) emerges, the country of origin can enjoy the booming period when every other country needs to pay premium to access the technology and the underlying value. What brought USA out from 1980's crisis is more than FED policy; it was first the PC then the internet that pulled USA out from previous recession and fuels the growth without having had USD weakened, inflation thrived, and trading deficit enlarged.

Following these products are the values: mass customization, a combination of responsiveness, niche market segmentations, and efficiency. It was origionated from USA, excelled in Japan, and perfected in USA again.

With the influx of money to embrace these values, USA has a large pool of capital. Under the loose FED policy, it leads to a rocketing growth of investment - even to areas that create transactional price but no realistic value, like derivative finance and derivative property markets. It means a waste of resources. High amount of liquidity, high amount of resources consumption, and low amount of value creation, result in today's financial collapse.

Constructive collapse it is.

A shift of paradigm will happen. Corporates, big and small, start to face this shift without knowing what the new values are. This is why global economies, particularly the previously largest beneficiary, USA, has entered an uncertain age. Uncertainty defines risk; and with a huge evaporation of non-asset backed or virtual-asset backed securities, investors become highly risk adverse, and take money out. There comes the difficult period.

Whether or not USA, and OECD economies, can resurrect from dying depends not on the financial saving measures. It depends on if any new values, represented by any new products, can be invented and wide-spreaded to the world, and embraced by the users and consumers. This is where opportunity for future lies.

Can it be environmental-related technologies that can shift our life-style from a simple open cycle to a more complicated, dynamically balanced, and recycling cycle? Or can it be simply another more advanced tools, like A.I. robots or genetically-engineered-what-so-ever-tools, that enhance production but still follow the same old values at the golden oldies?

I don't know.

All I know is: no matter it is Obama or McCain's office, as long as the new president embraces the changes and encourages the citizens to create, develop, and spread the changes, then USA can recover. Otherwise, it is just another Japan.

The same is applicable to China. The new world is knocking door. Open the door, and China will get the jewel of the crown. Open it not, China will be another S.E. Asian or Latin American country.

Long Term Interest Rates Drop

Long term interest rates, as shown on the 5 year and 10 year AAA rates, eventually drop in a consecutive 4 days, to 6.79% and 8.29% respectively. However, the spread between them and the FED target rates, 5.79% and 7.29%, remain high and higher than 3 months prior at 2.98% and 3.92% respectively. Further observation is needed to determine if the loan market will further lessen despite the fact that immediate liquidity issue is relaxed by FED money injection program. It can be further verified by the M2 supplies announced on thursday for last week.

Corporate bond market confirms this message. Corporate bond indexes show that the total return value, price, yield and volume of transaction increased. This is a mixed message: on the one hand the bond price advances with the drop of interest rate (i.e. discount rate); on the other hand, coupon also increases which indicates the issuers have to offer a higher coupon rate to attract investors for a justified risk-adjusted rate of return. Meanwhile, the volume increases reveals that equity market, to corporates now, is still not the market for finance. Nor do the investors are willing to completely return to equity market owing to the high risk of insolvency of corporates in the recent future.

Combining both the loan market and corporate bond market performance, even though corporate risk of immediate liquidity issue may have lessen by FED money injection policies, in the long run the risk of insolvency still exists. The market is resettling to a reasonable level, which is still high comparing with the level 1 year or even just 3 months prior.

Mortgage Rates also start to drop yet but a few basis points only - insignificant to claim the ease of property market. With the property market at risk, the down side of the equity market and even money market are still valid and threatening, though may not be at the paranoid level before.

US T-bill have price dropping and yield rising. An indication that money injection program injects some confidence to the market of which previously un-harmed investors start to long for relatively low P/E, i.e. cheap, stocks. Money is moving out from shelter to the market for the moment.

In conclusion, immediate liquidity issue of the market stops progressing. Bank is willing to do short-term loans as reflected on decreases on LIBOR. It is also willing to lend money to corporates at a safe (i.e. high) level. Corporates can borrow money to continue operation and longer term projects if they can afford a higher cost of equity. The once broken money flow is restored, though the volume and speed are way weaker than before.