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The China Effect

Today we present an abridged version of a new report examining China’s direct and indirect influences on global asset markets, and particularly equity, commodity and FX markets. The full version of the report is available to RGE Monitor premium subscribers. It takes a more in-depth look at Chinese commodity demand, the place of commodities within China’s foreign asset portfolio, as well as an update of our Chinese economic outlook. The full version also includes graphical analysis that should help readers parse recent trends in Chinese markets.  Enjoy the preview! Chinese Equities…

What’s on the Table at the U.S. China Strategic and Economic Dialogue (S&ED)?

U.S. officials and their counterparts from the country’s largest creditor, China, will take place next week in the latest of a summer full of key bilateral and multilateral meetings. In the run up to the G20 meeting in April, speculation about a “G2” consisting of the U.S. and China alone attracted a lot of attention, with many analysts noting that cooperation and compromise from the U.S. and China was needed for global progress on trade, climate change, global imbalances and a range of strategic issues.  While a formal partnership between China and the U.S. along the lines of a G2 is unlikely, the two countries are expanding the topics on the agenda of their formal dialogue. The first meeting of the a new bilateral dialogue, the  Strategic and Economic Dialogue (S&ED) will be held next week in Washington, DC, bringing together both countries’ top economic and geostrategic leaders.  What is on the agenda says a lot about the priorities of each government, but what’s not included may say more. As usual, the countries will focus on some of the areas on which they agree (short-term responses, big-picture ideas) with some thorny issues kept for the future. By formalizing these discussions, disagreements can be pushed through back channels, raising the prospect that some agreements may be reached before or as Obama visits Hu in China later this year. At the same time, one key goal of the S&ED under Obama is to make the dialogue less about deliverables and more about the ongoing contact between officials and their aides. During the Bush administration, U.S. and Chinese economic officials met twice annually for the Strategic Economic Dialogue (SED) to discuss a range of issues. Initially, expectations for these meetings were high, though they faded over time.  Secretary Paulson hoped to broaden the dialogue rather than fixate solely on the level of the RMB.  The cooperation delivered some victories, including cooperation on food safety and small steps towards a bilateral investment treaty.  The new grouping between the U.S. and China will meet annually and will take on a new set of issues – geostrategic as well as economic. President Obama will address the meeting on Monday morning, before a session on cross-cutting issues commences.  Climate change is expected to be the main topic of the first session, a move supported by the U.S. Senate Foreign Relations Committee. Climate change was an issue that was slightly out of the remit of the more economically-focused SED, but outcomes may be limited here given the diverging priorities .   While both sides have agreed to a $15 billion joint-research project on clean coal earlier this month, progress on climate change may be limited. After this, the strategic dialogue, to be led by Secretary of State Clinton and State Councilor Dai, will part ways from the economic dialogue, which will be led by Treasury Secretary Geithner and Vice Premier Wang.   While there is broad agreement on many of the issues that will discussed in these meetings (such as China needs to boost consumption and the U.S. needs to save more), the mismatch in priorities on each side is likely to limit any substantial progress. Moreover, even if the U.S. and China are “roughly in agreement” over economic issues, as the Economist optimistically puts it, their accord stems from short-term and very long-term issues. China and the U.S. have engaged in some of the most aggressive economic stimulus policies since the global meltdown, but they may differ in their positions on exit strategies. Moreover, there is not too much agreement on how the two countries will navigate in a world where China consumes more and the U.S. becomes a bigger saver. Chinese Priorities…

May TIC Data: Still Buying U.S. Assets, but Just the Liquid Ones

These days, the TIC data released monthly by the U.S. Treasury, detailing capital flows to and from the U.S., often seems anti-climactic given sharp moves in the FX and treasuries markets. Yet despite the lag, the data released yesterday, which details May purchases, tells a few stories. Most importantly, it illustrates the fact that in the face of capital inflows to overheating emerging market economies, the central banks of these countries kept buying U.S. dollar assets in May. Q2 was the first quarter of significant reserve accumulation of the last year. Preliminary estimates from RGE Monitor suggest that reserve accumulation was around $180 billion in the quarter (adjusted for valuation); the first significant increase since mid 2008. As in 2008, China accounts for the bulk of the accumulation (around $140 billion). Despite supra-national reserve currency rhetoric, and given Beijing’s reluctance to have its currency appreciate, there was little choice but to buy dollars. China added $38 billion in U.S. short and long-term treasuries for a net increase of $26 billion in U.S. short and long-term assets. The discrepancy can be explained by China’s reduction in its U.S. dollar deposits and its continued reduction in agency bond holdings.…

Chinese Reserves: Boiling Over Again?

Chinese reserves data released today seem to be one more sign that the Chinese stimulus might be working a bit too well. China’s reserves stood at $2.13 trillion up from $1.95 trillion at the end of March 2009.  Although reserve accumulation was likely lower than the headline $178 billion, it implies that hot money is back in China.  Adjusting for valuation, Chinese reserve growth was likely about $140 billion, much higher than the $60-70 billion of China’s trade surplus, FDI and interest income in this period.   This accumulation also suggests that China continues to have a hard time diversifying its holdings away from the U.S. dollar. Adjusting for valuation  -- the changes in value of the non-dollar holdings in China’s reserves -- would imply reserve growth of around $135-140 billion. This accumulation rivals that of Q2 and Q3 2008 for the highest quarterly level. It is one indicator that suggests that parts of China’s economy may be overheating as China tries all measures to stoke growth.  It seems well in line with almost 40% y/y urban fixed investment in May 2009, and loan growth equivalent to 25% of 2008 GDP. However, it just underscores some of the difficulties in both stoking growth and avoiding future distortions.…

RGE Monitor – China Economic Outlook: Q2 2009 Update

As we did last week with our U.S. economic outlook, this week we present a preview of our outlook for the Chinese economy in 2009 and 2010. The following is excerpted from RGE’s global outlook, which will be released to RGE clients later this month. The full version of the China outlook will include the following sections: Stimulus Boosting Investment: Pressing on the Same Levers Property Investment Stabilizing? Consumption Holding Up, But Can it Grow? Inflation and Monetary Policy: Leaning on the Banks Fiscal Policy and Effectiveness of the Stimulus Banks and Credit Market Vulnerabilities The Chinese Yuan and Equity Markets Chinese Reserve Accumulation and Diversification The RGE Monitor Global Economic Outlook presents analysis quarterly on over 70 countries and several crucial global issues.  Specifically, in this update, our analysts cover trade and protectionism, risks of rising fiscal deficits around the world, global imbalances and climate change, among other issues.  The complete RGE Monitor Global Economic Outlook will be available to Tier 1 Advisory Clients at the end of this week in advance of next week’s posting on the site for RGE Premium subscribers. And now for our China outlook.…

GCC Sovereigns: A Little Better Off

Timothy Geithner, the U.S. Treasury Secretary, travels to the GCC (Saudi Arabia and the UAE) in a few days to commune with some of the more significant creditors of the U.S. and possibly urge these savings-rich countries to contribute to the IMF, as several emerging market economies have pledged. As a result it seems an apt time to re-estimate how much these governments and their neighbors in Qatar and Kuwait have accumulated. While the Gulf’s holdings of U.S. assets pale in comparison to China’s, the GCC possesses the largest trove of US stocks among foreign governments. With most of its assets managed by the central bank, Saudi Arabia likely holds the most US treasury bonds. The other GCC countries, most of whom entrusted their oil windfall (and gas in Qatar’s case) to an array of investment funds, tend to have a more diversified portfolio. However, the U.S. dollar still dominates the Gulf’s foreign asset position. With the rise in the price of oil in Q2, some analysts have again been talking again about the global role of sovereign funds. While some, such as the China Investment Corporation (CIC), for one, seem to have become more active investors again, the Gulf funds still seem to be homeward looking. The latest –and forthcoming - RGE Monitor Global Outlook suggests that growth in the GCC will be flat in real terms, with a slight contraction. The significant assets of the region have allowed GCC countries to steer their economies to a softer, if still, harsh landing. Much of the region’s output, investment and sentiment remain linked to oil despite various attempts to diversify its economy. Steffen Hertog has a nice piece on the lessons learned from the 80s by Arab oil producers.…

Russia’s Reserve Currency Idea

The St Petersburg Economic Forum just wrapped up yesterday (June 6). Russian officials have traditionally used this forum to advocate for greater use of the ruble as a reserve currency, the importance of developing a financial center in Russia and in particular to point to vulnerabilities of relying on the U.S. dollar and U.S. financial regulation. They have also tended to pledge that Russia's investment climate will become more predictable and that Russia is putting diversification away from oil as a key priority. This year was no exception. Medvedev’s plan (which was downplayed by Finance Minster Kudrin)  envisages a set of regional reserve currencies (perhaps the ruble in the CIS etc, the RMB in parts of Asia) perhaps accompanied by greater use of the IMF’s special drawing rights.…

Brazil and China: Moves Towards a New Economic order?

Brazilian President Lula is the latest world leader (after Wen Jiabao and  Vladimir Putin) to call for moving away from the US dollar in trade and and for a new monetary and financial order. On the eve of his trip to China this week, Lula suggested in an interview with Caijing (and other news sources) that the two countries should conduct more of their trade in their own currencies rather than the US dollar. “Between Brazil and China, we need to establish a trade that is paid for in our own currencies. We don't need dollars. Why do two important countries like China and Brazil have to use the dollar as a reference, instead of our own currencies? We've already started doing this with Argentina. Our trade is taking place in our own currencies. Otherwise, we'll be in an absurd situation, where the country that caused this crisis will be the country that gets the most dollars. It's crazy that the dollar is the reference, and that you give a single country the power to print that currency. We need to give greater value to the Chinese and Brazilian currencies.”…

China’s Sluggish Q1 Reserve Growth

Chinese foreign exchange reserves data was released today – Reserves stood at $1.95 trillion at the end of March 2009, just under $8 billion more than at the end of 2008 -  a much slower pace of growth than in 2007 or 2008. Bloomberg notes "The currency reserves plunged by $32.6 billion in January, the biggest monthly decline since Bloomberg started compiling data in 1996. The holdings shrank by $1.4 billon in February and expanded $41.7 billion in March." To a large extent this slow growth was not a surprise. The $30bn nominal drop in fx reserves was leaked to the press a few weeks ago – and as usual, the leak was pretty accurate. Furthermore, it fairly consistent with other indicators that Chinese macro conditions were under severe stress at the beginning of the year.…

GCC sovereigns Resort to the Bond Market

In recent days and weeks, most of the GCC governments have announced plans (or hinted at) issuing sovereign bonds. Kuwait, Abu Dhabi, Dubai (of the UAE), Qatar and Bahrain have all suggested they would issue bonds in coming months, totalling several billion dollars. In recent years, the issuance of sovereign debt by GCC governments has been quite limited to Bahrain and Oman in light of the enormous surpluses accrued in light of the once-soaring oil prices.  In fact a few sovereigns, and sub-sovereigns like Abu Dhabi, did not even have credit ratings. Instead most of the limited bond issuance was by government-linked companies throughout the region. Yet,  and as we have explained in a recent piece, with the reversal in hot money,  in addition to the the losses and continued losses in the region’s equity markets, the cost of long-term borrowing sky-rocketed, highlighting the vulnerability of relying on external finance even as new revenues began to fall as investment returns and oil revenues fell sharply. Also, with external finance expected to grow at a slower pace in the face of the continued global liquidity crunch, GCC countries are left with no other option but to try to explore other sources of financing to tap the latent funds available in the region and from foreign investors looking for relatively safer credit risks.…