China follows world trend in
raising rates By Laurence Lau
The action by China's central bank in
raising lending rates to 5.85% would not have been
so important if it had not come at a time when the
United States is doing the same - and may do it
again. With interest rates already climbing in the
US and Europe, and with monetary officials
starting to tighten policy in Japan, China seems
to be joining the world's central bankers in
trying to gain control of speculation that has
driven up prices of such assets as gold and real
estate.
The Chinese action aims to slow a
spectacular surge in investment, and it may
potentially brake China's voracious appetite on
world markets for oil and other commodities. From
steel mills and auto
factories to luxury apartment buildings and plush
office complexes, China has been engaged in a
nationwide building boom fueled by easy loans. New
loans soared at least 61% in the first quarter of
this year, causing investment in factories and
other fixed assets to climb 29.8%.
The
boom in lending and investment, which has
contributed to China's rapidly rising exports,
pushed growth in the economy to 10.2% in the first
quarter. That was high even by China's
extraordinary standards - so strong that President
Hu Jintao himself warned in April that the country
needed efficient, high-quality development and not
"excessively rapid economic growth". Premier Wen
Jiabao also warned that China would move to
tighten controls on real estate and lending.
One can understand why China needed to
raise rates. However, it came about in an
environment in which its currency is also
appreciating. The rates-squeezing movement in the
United States and the European Union has also
forced second-tier players, such as the smaller
Asian economies, to follow suit. Now we have a
situation where most stock markets, interest rates
and currencies are on an uptrend. The exception is
the US, where the dollar could come under more
pressure.
Usually higher rates would
stifle equity markets, but that mechanism seems to
be ineffective for the time being. This is even
more surprising in that oil prices are also
stubbornly high, not to mention other commodities,
including gold. Long-term observers of gold would
note that gold rallies tend to coincide with long
periods where returns from other asset classes are
diminished. Again, that does not seem to apply for
now.
Growth in equity markets will
eventually slow because of higher rates, but
investors are also attracted to potential gains in
respective countries' currencies. So what gives?
These are the important conclusions:
1. The US is printing buckets of money. To
finance consumption in the US, the number of
dollars in circulation has to rise. As long as
there are willing holders of US Treasury bonds,
nothing really bad will happen.
2. More
funds are chasing all kinds of assets. The result
is higher demand for all commodities, whose
supplies are limited, thus pushing prices higher.
Hence one can argue that in every case assets are
rising because of higher dollarization, not
productivity values. To that end, timber and
palm-oil prices should have a lot more room to
rise in the foreseeable future.
3.
Investors are still pouring funds into stocks in
almost all markets, chasing equity and currency
gains at the expense of the US dollar. They will
continue to do that until the dollar drops
substantially, thus improving actual returns of
investors (hedge funds included).
4. Rates
cannot continue to rise without something
happening to asset prices. Already equity markets
in China are among the worst first-quarter
performers. Surprisingly, equity prices in the
United States have surged. The inevitable will
happen: there will be more rate hikes in the US,
and the bottom will fall out.
5. While I
have been a believer in the resilience of the US
dollar, it appears that the moon and stars have
aligned to force the issue. If the US Federal
Reserve tries to delay a substantial correction,
it will have no choice but to raise rates again.
The next rate increase may still not be sufficient
to derail the status quo. I figure a increase of
150 basis points from now should do it.
6.
What China is doing in raising rates is more to
protect its domestic overheated economy.
Additionally, China will allow for the yuan to
appreciate gradually. Both will have a depressing
effect on Chinese stocks this year.
7.
Smaller emerging and developing markets, such as
Singapore, Malaysia, Thailand, Indonesia and Hong
Kong, will be forced to follow suit on any
US/China rate increases. However, their stock
markets would have a better chance of rising
further, having recovered from the 1997-98 crash.
A substantial correction in the dollar would spell
a temporary end to their bull runs, as investors
would then be able to lock up gains and cash out.
Is there any way the US dollar could stave
off devaluation of 15-20% or more from its current
values? Not this time, as every single asset class
seems to be ganging up to push the dollar lower.
How many more rate increases can the Fed make to
support the dollar without derailing the US
domestic economy?
Oil prices can stay high
while rates rise, and equity prices rise because
demand generally comes from real productivity
demand. Even if you pay a higher price for a
commodity, it still works because the product used
generates sufficient improvement in productivity
in such countries as China and India.
Consuming nations such as the US and Japan
will have to bear the burden, as that will eat
into margins without sufficient improvements in
productivity. For Japan, the case is slightly
different because it is finally emerging from its
deep, 13-year recession. Hence the economy can
withstand many more rate increases from it "zero
rate" base.
Chinese officials were
probably not worried about inflation, given that
the consumer price index in China was just
eight-tenths of a percent higher in March than a
year earlier. That is a luxury the Fed does not
have in the US. Meanwhile, the smaller Asian
nations should be able to better cope with
inflation via their appreciating currency.
Laurence Lau has more than 18
years of experience in business/finance. Born in
Malaysia, he has worked in Sydney, Singapore, Hong
Kong and Kuala Lumpur. He was head of research for
two securities firms and a portfolio manager for a
UK firm.
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