Monday, February 29, 2016

1.8 Million Job Cuts

The announcement of the cut in banks’ reserve requirements made a general reference to economic restructuring. The move does not seem so large when you put it up against the specifics announced today: 15 percent across the coal and steel industries, or 1.8 million workers, which I believe qualifies as the largest single layoff announcement in history. Coal and steel are closely connected in China because so much of coal production feeds into steel production. The Reuters report at The Guardian:

This announcement was unexpected because coal and steel are far from the heart of the overcapacity in China’s industrial economy. The excess capacity in construction, for example, is surely greater than 3 million workers. Nevertheless, it all ties together. Cuts in construction, industrial equipment, or any of a dozen other industries would necessitate cuts in steel, which in turn requires cuts in coal. Reducing capacity in coal and steel might as well come first.

The nature of the adjustments points to past imbalances in the economy as the central government pursued glamour over substance in economic development. In solar panels, for example, central government policy supported solar manufacturing strictly for export, even though domestic need for solar capacity was and remains greater than that of the countries factories were trying to export to. Surely China’s economy could be more balanced if practical and domestic needs were not so subservient to marquee export categories.

The drastic cuts in steel point to quality issues. China for the past half century has been known for cheap steel — low prices, but also the lowest quality of any steel producer in the world. Product quality scandals in a wide range of categories have made it a challenge for China to keep exporting.

One of the latest scandals involved laminate flooring which U.S. retailer Lumber Liquidators had custom-manufactured in China. Tests shows illegal levels of industrial solvents in the products. Chemical levels were so high that the Centers for Disease Control (CDC) estimated the cancer risk of a person living with the tainted flooring to be not much less than 1 in 100, and other less serious diseases were far more likely. Lumber Liquidators could go bankrupt because of the scandal, and it has responded by banning all Chinese-made laminate products from its stores. This story at USA Today:

This is just the latest example of how an entrenched indifference to quality can make it difficult to maintain a market position. In a world that is becoming more product-conscious, China will have to make that adjustment as well. Other U.S. retailers pulled similar products, and at least a generation will have to pass by before Chinese-made laminate flooring can get a second chance at the U.S. market.

For these and other reasons, the 1.8 million job cuts announced today for the coal and steel industries are just the tip of the iceberg, and it is hard to imagine that the industrial restructuring can get very far before more monetary easing is forthcoming.

Reserve Requirement Cut to 17 Percent

The People’s Bank of China is cutting the reserve requirement for banks from 17.5 percent to 17 percent effective tomorrow. Detailed context and analysis from Pete Sweeney at Reuters:

In theory a reserve requirement cut makes banks more active and profitable but less stable. The move makes it easier for banks to make new loans. It also makes it easier for banks with stock market loans and other problem loans to extend those loans even though the borrower may not soon be in a position to repay them. In a similar way, it makes it easier for the central bank to leave financial troubled banks standing a little longer.

Friday, February 26, 2016

Central Bank Governor Emphasizes Stability

China’s central bank governor Zhou Xiaochuan held a press conference today only to say that the central bank wasn’t doing or seeing anything particularly new and different in China’s national economy. Zhou said stability remains the key objective of the central bank and rejected any suggestions of using monetary gimmicks to prop up exports or any segment of the economy. He offered an optimistic assessment of the national economy. The story at Xinhua:

For the U.S., Fewer Goods Means Fewer Trucks

In the United States there are mass layoffs in factories that produce medium-sized trucks, ones roughly 7 to 14 meters in length. Orders for trucks in this size range have almost come to a stop in some regions. Indirectly, this is bad news for manufacturing in general. These are the trucks of the distribution system, the ones that move manufactured products from factory to warehouse to store to home. There is no need for more of these trucks this year because U.S. consumers are purchasing a smaller total volume of goods, a trend that is expected to continue into next year.

Wednesday, February 3, 2016

Could the Scale of the Banking System in China Force a Rescue Effort?

Has the Chinese banking system grown too large?

CNBC interviewed a fund manager, Kyle Bass, who is betting that it has.

The premise of Bass' bet goes like this: China's banking system has grown to $34.5 trillion, equal to more than three times the country's GDP. The country is due for a loss cycle . . . central bankers will have to dip into China's $3.3 trillion of foreign exchange reserves to recapitalize the banks, causing a significant depreciation in the value of the yuan . . .

For comparison, the U.S. banking system is around 1 times annual GDP, making it considerable smaller than that of China. The United States pursued deeply inflationary policies for years (though the economy proved resistant to inflation) after 2007 to rescue its banking system. After just a few large-scale shocks such as failed real estate or energy projects or natural disasters, China’s banking system could be weakened enough that China may be forced to follow a similar path. If that were to occur, there is no guarantee that the Chinese economy would resist the subsequent inflation.