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A Warning: What China’s credit tightening tells investors

By Jim Trippon

China kicked off its Lunar New Year holiday with a bitter pill for investors. China’s central bank ordered lenders to set aside larger reserves…the second time in a month it has done so. That Even the Chinese press isn’t buying that line wholesale anymore. One newspaper described the latest action as a government effort to “freeze more money from lending.” Starting February 25th the reserve ratio, the share of deposits that banks must set aside as reserves, will increase by 0.5 percent on yuan deposits.

Chinese investors were spared the aftershocks because the Bank of China made its announcement after stock markets had closed for the lunar holiday. But investors in Chinese equities on this side of the Pacific weren’t so lucky. The Bank of New York Mellon China ADR Index gapped down 2% as markets opened on Friday, and recovered only slightly as the trading day came to a close.

China’s latest credit squeeze was also blamed for a very weak opening for U.S. stocks as key American indexes slumped in the one percent range on Friday.

Investors should expect even more credit tightening from Beijing as the inflationary effects of China’s lending boom and its increasing money supply ripple through the economy.

Unfortunately, the latest inflationary figures were wrongly celebrated. The media concentrated on a very slight “easing” of the China’s Consumer Price Index. The January CPI was up 1.5% from a year before, compared to December’s 1.9% rise.

Much more importantly, January’s Producer Price Index shot up. Wholesale inflation, as it is sometimes called, accelerated to 4.3 percent, up from December's 1.7 percent rate. This means consumers are almost certain to face similar price hikes in the future as retailers pass on their higher costs.

Also, housing prices rose 9.5 percent in January from a year earlier in seventy large and medium-size Chinese cities. That was 1.7 percentage points higher than December's housing price rise, the highest increase in 21 months.

It’s only a matter of time before Beijing takes further action to tighten credit, potentially by raising interest rates.

The effects of monetary decisions in Beijing on stock markets half a world away demonstrate once and for all the importance of China to global economic stability in the eyes of investors. The sensitivity of U.S. markets to relatively minor monetary tremors from China may seem irrational. But the plunge of U.S. indexes after Beijing’s latest decision signals the extreme fragility of investor confidence in the U.S. economy.

Professional gloom-monger, Marc Faber, made headlines by predicting that monetary tightening in China could cause an economic crash there. Nonsense. China’s booming economy does have well-recognized weaknesses. But we can be certain that Beijing’s economic commanders will move swiftly, and that they have the funds to deal with any danger signs that may appear. Never underestimate China’s determination to continue its growth curve.

More frightening for investors is the potential for U.S. monetary tightening to hurt American stock markets, especially considering their extraordinary sensitivity to Chinese monetary maneuvers.

The U.S. government cannot continue to lend money at near zero interest rates in its ongoing effort to revive the economy. When Washington finally taps the brakes, look out Wall Street.

Jim Trippon,
China Stock Digest Editor-in-chief

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