No Fireworks At The G20

At the recent G20 summit, central banks undertook no action to strengthen world currencies or to strengthen their efforts to create economic growth. Most significantly, Chinese Premier Li Keqiang and central bank governor Zhou Xiaochuan seem to have dispelled worries of visiting central bank chiefs that weakening the Chinese yuan is a central component of their economic plan, making it abundantly clear that China’s growth strategy does not hinge on such a devaluation (even though the yuan has risen significantly against the currencies of China’s major trading partners over the last 5 years). Speculators may not agree.

Reserve Requirement Cut Shortly After the Meeting

China did not disappoint the optimists when shortly after the meeting they announced a new cut in reserve requirements by 0.5 percent to 17 percent. We expect a reserve requirement cut each quarter in 2016, and probably two more interest rate cuts from a one-year benchmark lending rate which is currently at 4.35 percent, and which we expect to fall to 3.85 percent this year.

All of this will work to stimulate economic growth in 2016, but it will also work to sow seeds of overleverage and cause major problems for China in a few years. However, we see no economic problems for China in 2016.

Another issue is that China continues to lose exchange reserves at a rapid rate, as many corrupt Chinese seek to avoid prosecution and get their money out of China before the axe comes down on them as part of President Xi’s anti-corruption campaign. Most significant is that many speculators who have borrowed Japanese yen and invested in Chinese yuan during the long run-up in the yuan’s value, and who also benefitted from much higher interest rates in China, are now turning tail and running for the exits. They are selling yuan and paying off their yen loans, causing much of the loss of foreign exchange reserves.

The reserve requirement cut will continue to stimulate China’s economy, and that will make the current real-estate expansion in China continue a bit longer. We anticipate that China’s GDP will grow by about 5.5 percent in the first half of 2016, and about 6.5 percent in the second half, for an average of 6 percent in 2016. By global standards, this is a very rapid rate of economic growth.

There has been a great deal of fear about China, much of it unreasonable. This phenomenon is not new -- there has been a great deal of unreasonable fear about China’s economic outlook for several years, and the fears have not materialized. China’s GDP will grow nicely in 2016, especially in the first half, although stimulus will be sowing the seeds of longer-term problems as the banking system becomes more over leveraged. If you disagree with our analysis and the analysis of the China economists who we respect, be sure to call us and we will recommend the best China analyst we know, who has had an unparalleled record of success identifying the Chinese economic outlook for the last decade and longer.

Investment implications: Last week’s summit of the finance ministers and central bankers of the world’s 20 biggest economies was a tame and mostly uneventful affair. Most significantly, China assured the participants that their economic growth strategy doesn’t hinge on the devaluation of their currency. Shortly after the meeting’s conclusion, the People’s Bank of China cut reserve requirements, which should deliver some economic stimulus and prolong the current real-estate expansion. We reiterate that while we see eventual problems in an over-leveraged Chinese financial system, those problems are some ways off -- and in the meantime, the world’s second-largest economy is far from recession, in spite of irrational fears. China’s economy is growing at about 5 to 6 percent, stocks are cheap, and we may be surprised how well the Chinese market does in the next few months. Deflation fear is ending as materials and oil prices are bouncing up, leading to even faster GDP growth in China.