By Greg Grunsted
The great economist was referring to financial crises and corrections as necessary components of a healthy free-market. This ‘shower’ is needed to cool things down and clean out the infective elements that build up during all economic cycles. Then, as after the nausea and vomiting experienced when one contracts a bad flu, the economy begins its recovery.
Conversely, when government prescribes too much to alleviate these painful symptoms such as misregulation, over-regulation, etc., these infective elements have less of a chance to surface thus preventing them from being dealt with properly. The result is an extended recovery with greater cost and discomfort.
China is not immune to Schumpeter’s cold shower
As with the 1997-98 currency collapses, starting in Malaysia and circumnavigating the globe to Brazil, today, again, free market forces are aiding economies around the world in identifying these infections. The good news is this correction, though broad, is happening quickly. The bad news is that the ensuing confusion may allow for some misaligned policies to be forced into place -- impeding recovery.
Generally the Chinese economy remains in very good shape. The Peoples’ Bank of China’s (PBoC) estimates of GDP growth, although down an annualized 1.8 percent, still ran at an impressive 10.4 percent for the first half of 2008. Retail sales,imports, household income, corporate profits and revenues all continued to rise. Among the PBoC’s concerns are the impacts of the current credit crisis on both China’s domestic economy and the global economy, and inflation which ramped up to about 4.8 percent through 2007, and has been annualizing at 7.9 percent for the first half of 2008, though easing a bit to 4.9 percent in August.
China’s National Bureau of Statistics’ impressive array of economic indexes measure economic sentiment and aid greatly in gaining visibility into the directions and momentum of entrepreneurial and consumer activity. Indications, however, show expected nervousness. Despite the Chinese economy’s strong performance, concerns for the global economy have had animpact. China’s Consumer Confidence Index is sitting in the 93 range which is good but has been fading a bit. Any rating below 100 is an indication of negativity. Also, the Entrepreneur Confidence Index is showing a slowing of momentum. Other measures such as the National Business Climate Index and the National Real Estate Climate Index also show stress despite solid overall growth in year over year numbers.
As with other regions around the world, China’s residential real estate market is experiencing rising inventories which current estimates indicate will continue through 2009. The increase in housing prices in China’s 70 biggest cities fell from double digit appreciation in 2007 to early 2008 to 5.3 percent in August, just slightly above the inflation rate. China’s investor sensibilities could not seem to resist the speculative flu in real estate being felt elsewhere and joined in around 2001. In 2005 The Economist magazine called the then current housing boom “The biggest bubble in history”, and for some time prior had been critical of the expanding real estate valuations and related lending practices. The total value of residential property in developed countries had risen in recent years by over US$30 trillion to over US$70 trillion by 2005. These price appreciations occurred throughout the developed and developing world and included most of Europe, Hong Kong, Australia and New Zealand, South Africa,etc., and examining measurements such as median household income to median homeprices, and monthly cash flows of owning versus renting finds that both ofthese ratios hit historically high levels at the peak of this boom.
People’s Bank of China and the Chinese government have been closely watching developments of the U.S. financial crisis and its impact on China and the rest of the world. Official statements from President Hu Jintao and the PBoC have been supportive of the efforts behind the Emergency Economic Stabilization Act of 2008. In emphasizing the importance of international concerns to China’s growth, they clarified their efforts to strengthen cooperation with involved economies, maintaining confidence in the financial systems and monitoring volatility in the various markets.
So far China’s financial institutions appear to remain relatively untouched by this crisis. They currently hold an estimated US$1.7 trillion in foreign exchange reserves, enough to possibly take advantage of bargain-price shares in the worlds contracting banking and real estate companies. However, many Chinese banks are heavily invested in U.S. government securities, including Fannie Mae andFreddie Mac bonds. On Oct. 3 the PBoC reiterated its efforts in dealing with the global financial crisis and strengthened efforts to boost domestic demand and protect growth. On Oct. 8, China’s central bank, in an effort that coincided with global central banks’ initiatives, cut interest rates for the second time in three weeks and lowered banks’ reserve requirements in an effort to aid in halting a free-fall in world financial markets.
The impact on China shares
As of Jan.1, 2007, China’s market capitalization of publicly traded shares was approximately US$4.47 trillion. Since then the Shanghai Composite Index alone has been cut by more than 65 percent driving the price/earnings ratios for Chinese stocks from the 40s to the midteens as of October. Reasons for this include a shaky outlook for export demand, and questions of visibility in the Chinese financial sector.
China’s financial system is very closely influenced by its government, with the government maintaining significant equity stakes. Impacts of performance on their loan portfolios aren’t really clear yet, and the potential for losses could affect the ability for financing and capital formation needed for growth. Still, with the fast overall growth and excellent future prospects, the economy should be able to perform well long-term indicating current prices may actually be offering great opportunities for those with patience.
With volitility comes uncertainty, and this can affect even the most solid situations. When coupling growth companies inside a growth economy, factors can compound and have the effect of driving prices to surprisingly low levels, creating very attractive situations.
Looking ahead: Financial crisis and scandals (real or imagined) have always existed
In 1792 Alexander Hamilton organized the first public offering of securities in U.S.history: treasury bonds used to finance the building of the U.S. Navy. This offering was also noted for much insider trading and scandal. This Navy went on first to be used in the battle at Tripoli in 1801, in the First Barbary War, and marked the first time the United States projected military influence in another part of the world. In 1720 the economy in Europe was rocked by a speculative bubble involving a French outfit called the Mississippi Company, intended to finance trade with the (then) NewWorld. Its failure affected the European economy for decades, eventually influencing revolutions in France and America. More recently, the 1987 stockmarket crash took less than a year to recover, and the 1997-1998 currency collapses were soon followed by a strong stock market bull run.
So the question changes from, “How do we prevent the next financial crisis?” to “What do we do when the next financial crisis occurs?” No doubt some of the great names in business(Bear Stearns, Lehman Brothers, Merrill Lynch, etc.) will disappear as separate entities. And we can argue about who’s responsible for the over leveraging of the financial industry and the poor to non-existent credit standards that prevailed in real estate. Certainly in the U.S. regulatory agencies; including the Federal Reserve Bank, SEC, Senate Financial Services Committee, various states attorneys general, etc., should have sounded a warning, and a few individuals did. – No doubt politics played a role.
The upcoming quarters should be a more newsworthy. We have many reasons to remain positive. The current financial landscape will change. But there’s much movement right now, and talent and drive don’t just go away; economic vacuums will be created which will not last long. Ideas look for capital and dollars look for ideas, and market forces will continue to find ways to put the two together. (Note: as of Sept. 19, Wells Fargo, Bank of America, UBS, and Twin City Federal have all made strong recoveries, and already new firms are being created.)
The current financial crisis calls out for new ideas as well as more, not less,financial information about what’s prudent and profitable in the future environment. It’s easy to be pessimistic right now, but indications are for increasing demand for this internationally among developing economies, as well as with the maturing demographics in the developed countries.
Feltl & Company