Being Street Smart December 10/04
by Sy Harding
December 10/04
CHINA AS A BELLWETHER?
A number of years ago I predicted China was the country most likely to
give the U.S. serious competition as a world power in coming years. The
response was skepticism (to put it mildly). Communist systems had collapsed
around the world and China would obviously continue to be a backward,
over-populated nation unable to even feed its own people. Being ignored
was China’s bold move to bring about a free-market economy within
a communist political system.
That it has worked is an understatement.
In just a few years China has become a sizable force in international
economics and trade. It has become an important producer and consumer
of the world’s products, so influential that the energy demands
of its booming economy are blamed for the spike up in oil prices of the
last two years.
Thanks to the world-wide revenues it receives in U.S. dollars, which it
currently recycles into U.S. bonds, China is also becoming an important
cog in the financing of U.S. debt.
China is also flexing its muscles in the area of international trade.
It recently finalized an accord with nine other Asian countries aimed
at creating the world’s largest free-trade zone, with the goal of
decreasing the influence of the U.S. on international trade. Countries
involved have a total population of more than two billion people. That’s
a lot of consumers.
In yet another sign of China’s emergence as an economic power, IBM,
which introduced the personal computer to the world in the 1980s, announced
this week that it is selling its PC business to Chinese computer company
Lenova Ltd, in a $1.7 billion deal. The acquisition boosts Lenova from
eighth place to third place among global computer makers.
There is no doubt that China has grown to considerable international influence
in a relatively short period of time.
So much so that economists are concerned that if its booming economy is
in a bubble and it should burst, it would have a domino effect on economies
around the world. The Chinese government has the same concern and has
been taking steps to let some air out of the bubble by raising interest
rates. The problem is that central banks, including the U.S. Federal Reserve,
do not have a very good record of cooling off overheated economies. They
most often overdo it and send economies into recessions.
We may be able to get a clue of what will happen to China’s economy
by looking at its auto industry.
When prosperity comes to an individual, or an entire population, the prosperity
usually shows up first in a new car in the driveway. Chinese consumers
did not deviate from that pattern.
As Chinese consumers earned more and felt more prosperous, auto-sales
in China grew dramatically over the last five years, but then became ballistic,
growing more than 60% a year in each of 2002 and 2003, and beginning this
year with a leap of 40% in the first quarter. To handle the growth, auto-makers
built plants and built plants until there are now more than 100 auto plants
in China churning out cars to meet the demand. Volkswagen, General Motors,
and Honda are the three largest foreign companies with substantial joint
venture investments in auto plants in China.
However, last spring the Chinese government realized that defaults on
car loans were running at more than 50% in the cities of Beijing and Shanghai.
It cracked down on easy credit. That sent the auto sector into a tailspin.
Not only have auto sales flattened, but profit margins have collapsed.
Two years ago profitability for auto-makers in China was a mouth-watering
28% compared to 5% globally. In a recent report Credit Suisse First Boston
estimates profitability dropped to 20% last year, and is still falling
as manufacturers cut prices to try to move inventories.
The Chinese stock market, like the stock markets of non-communist countries,
anticipates problems well in advance. So it should not be surprising that
the stocks of Chinese auto companies have plunged an average of 40% this
year.
In those ‘old days’ when the U.S. was in the same stage of
its industrial and economic development, when the auto industry was the
most important sector of the economy, the auto industry was also a fairly
accurate bellwether for the entire economy and stock market. That is,
when the auto industry went into a tailspin it almost always pulled the
rest of the economy (and stock market) down with it.
I believe the problems that have beset the auto industry in China raise
the odds that China’s central bank will not be successful in bringing
China’s economy in for a soft landing.
If I’m right, then the next question will be whether China has really
reached the level of international importance that a serious plunge in
its economy would spread domino-like around the world.
For now that should not be of concern. The market is in its favorable
season. It is even in the three months (November, December, and January)
that are typically the most positive months within the six-month favorable
season.
However, next year, as we enter the usually most troublesome first two
years of the next Four-Year Presidential Cycle, China’s economy
needs to have our attention, perhaps even more than our own economy.
Sy Harding is president of Asset Management Research Corp., publisher
of The Street Smart Report Online at
www.streetsmartreport.com and author of 1999’s Riding The Bear
– How To Prosper In the Coming Bear Market.