Column

THE TIME OF THE TIGER

DONALD COXE July 26 2004
Column

THE TIME OF THE TIGER

DONALD COXE July 26 2004

THE TIME OF THE TIGER

China’s economy has come roaring back, shrugging off the pundits

Column

DONALD COXE

IT’S OFFICIAL: this is China’s century. That’s the proclamation in a splendidly researched cover story in the New York Times Sunday magazine issue published—so no one could miss the significance—on the Fourth ofjuly. By coincidence, the article, the best I have read on the subject, appeared at a time investors were scrambling to shift their bets on the global economy from the United States to China. The result: U.S. stock indices, led by Nasdaq, slumped; Chinese stocks rose sharply. The U.S. dollar fell in global currency markets, driving gold back up through the psychologically important level of US$400 an ounce.

Prices of major industrial metals rose, analysts said, in response to rising Chinese demand. As a result, share prices of major mining companies leapt. The most-watched global cargo shipping index, the Baltic freight index, which had been sagging through the second quarter, rose 10 straight days in late June and in early July in a surge attributed to rising demand for space on ships serving Chinese ports.

From February until late June, global investors had been selling Chinese stocks. They left their U.S. exposures alone, as U.S. stock markets were going sideways: the positive effect of soaring corporate earnings was offset by bad news from Iraq. The consensus view was that the U.S. economy was continuing to strengthen, whereas the Chinese economy was weakening rapidly under government pressure to slow the juggernaut. A new cottage industry of experts on the Chinese economy was proclaiming that the slowdown would become a crash—a replay of China’s vicious plunge of199294. Among the shrillest was BusinessWeek, which I noted in an earlier column has a reputation for overstating the case.

What happened? As for the changed U.S. outlook, nobody is sure why the economic data changed so fast. Yes, the Federal Reserve finally raised its federal funds rate from one per cent to 1.25 per cent, but that was expected. And no one believes that moving the rate from the nearly microscopic level to the microscopic level will hurt the U.S. economy. There was only one warning sign before the sudden slowdown in June: for weeks, money supply growth

THERE is near-zero risk that a huge percentage of China’s economy is headed for collapse, because not all the multinationals will create excess capacity at the same time

had been decelerating. A few monetaristoriented observers raised the alarm, but most investors insisted the economy was still gaining speed. Then, automobile sales slumped, despite near-record price discounting from the Big Three. Then, on July 2, the nonfarm payroll report for June shocked Wall Street, as the number of net new U.S. jobs, expected to be at least 200,000, as in the previous three months, came in at a mere 112,000— and the previous two months’ strong gains were restated downwards.

At the same time, discount kings WalMart and Target reported significant sales declines after months of steady gains. The monthly purchasing managers’ reports from both the manufacturing and the service sectors, released in the first week ofjuly,

showed unanticipated declines. Leading business software firms, such as Veritas, reported late-June collapses in new orders.

Economists are scrambling to explain why the boisterous economy has suddenly becalmed. FTigh oil prices are blamed, although they actually fell from US$42 to as low as US$36 during June, before climbing anew injuly. Fear of rising interest rates is cited as a constraint on consumer spending and a sudden stickiness in sales of existing homes. The Reagan funeral is also named as a likely culprit—observers say consumers spent time watching TV rather

than money in stores. What those “explanations” really mean is that there are new doubts about the health of the American economy. That means investors will be eyeing the economic and earnings reports in coming weeks with great concern.

As for China, investors’ renewed enthusiasm for the Middle Kingdom comes from the growing belief that the commissars in Beijing don’t really have a tough challenge. It has only been a few months since their biggest fear was deflation, so a little inflation is actually welcome. The commissars don’t dare try to drive their double digit economic growth down to a level that would be regarded as fabulous in sclerotic Europefour per cent or so.

Meanwhile, millions and millions of Chinese are employed in state-owned operations, few of which make money. Giving people low-paying jobs in profitless factories is deemed better than giving them handouts. But won’t those factories go bust, thereby bursting the Chinese bubble?

In reality, what really drives China is the branch plants of foreign-owned companies.

Foreign direct investment gives China more than jobs: it provides capital, technology, management, global brands and distribution. No other Third World country seeking First World status has relied so heavily on Western know-how. That means there is near-zero risk that a huge percentage of China’s economy is headed for collapse, because not all the multinationals will create excess capacity at the same time.

At least, that’s what many global investors are telling themselves these days as they go back to buying Chinese stocks and shares of Western mining and oil companies. The U.S. is no longer an economic hegemon. And despite its grandiose hopes, the EU is not No. 2. It’s China. Hfl

Chicago-based Donald Coxe is Global Portfolio Strategist, BMO Financial Group. dcoxe@macleans.ca