China's Tightening Is a Good Thing


China sees a bubble ahead and is trying to avoid it—is that such a bad thing?

China sees a bubble ahead and is trying to avoid it—is that such a bad thing?

Isn't this what we expect Ben Bernanke and the Federal Reserve to do here at home—take clear and decisive action to drain off excess liquidity in the economy before inflation takes hold?

The People's Bank of China did just that after it saw that 1.4 trillion yuan ($204 billion) worth of bank loans were issued in January, more than the total loaned in the three previous months combined.

For all of 2010, the target loan amount is 7.5 trillion yuan, so it's easy to see why the government might want to slow the pace a bit.

Forbes' online headline was "China Tightens the Screws," but let's have a little perspective.

Barclays Capital predicts that the 0.5% increase in bank reserve rates (from 16.5% of deposits to 17%) will remove 300 billion yuan from the Chinese economy. That's only 20% or so of the amount loaned in January.

And it's not like cash is going to dry up—the People's Bank plans to increase the nation's M2 money supply by 17% this year. January's M1 money supply report showed a 39% increase (chart above). Not exactly a screw-tightening.

China's CPI rose 1.5% in January, which is not extreme, and the chart above from BCA Research shows that real estate prices in terms of per-capita income had not entered a bubble phase as of year-end. But perhaps the more telling number was wholesale prices—up 4.3% year-over-year and more than double the increase seen in December. This signals that higher inflation at the consumer level could be around the corner.

Markets are taking a hit based on this news—this shows how important China has become to the world economy. It surpassed Germany as the top exporting country by value at $1.2 trillion, and in January its exports were up 20% compared to a year earlier. Even better, its imports were up 85% year-over-year.

What we may actually have is a classic bull market in the making—one that climbs the proverbial wall of worry, which suggests that investors buy on corrections. The table below shows the standard deviation (sigma) over 10 years for the main stock markets in mainland China and Hong Kong. The weekly sigma for the Shanghai A-share market is plus or minus 5%, while its normal quarterly swings can be nearly 25% up or down.

It's nearly impossible to pick exact tops and bottoms—adding to core positions after any correction greater than one sigma is a safer and more prudent way to invest.

Beijing is tending to its economy so it performs over the long term. This is central to its goal of social stability through economic prosperity, and it seems to be working—millions of households join China's middle class every year.

We all know what can happen when an asset bubble grows huge and then bursts—we're still recovering from 2007–08.

China is a long-term growth story, and how well it manages that growth will have an impact on all of us. A little caution now should be seen as preventative maintenance, and we all know that when we're talking about cars or economies, that's a good thing.

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All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. M2 Money Supply is a broad measure of money supply that includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M1 Money Supply includes funds that are readily accessible for spending. Standard deviation is a measure of the dispersion of a set of data from its mean. The more spread apart the data, the higher the deviation. Standard deviation is also known as historical volatility. The CSI 300 is a capitalization-weighted stock market index designed to replicate the performance of 300 A-share stocks traded in the Shanghai and Shenzhen stock exchanges. The Hang Seng Index is a capitalization-weighted index of 33 companies that represent approximately 70% of the total market capitalization of The Stock Exchange of Hong Kong. The Shanghai B-Share Stock Price Index is a capitalization-weighted index that tracks the daily price performance of all shares listed on the Shanghai Stock Exchange available for investment by foreign investors. The index is priced in US dollars. The Shenzhen B-Share Stock Price Index is a capitalization-weighted index that tracks the daily price performance of all shares listed on the Shenzhen Stock Exchange available for investment by foreign investors.

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