Watch what China does with US debt, not what it says
Last updated: October 15th, 2013
The latest data shows that China's foreign reserves soared by $163bn in the third quarter to $3.66 trillion, one of the biggest jumps ever.
Mark Williams and Qinwei Wang from Capital Economic called the rise "astonishing". They estimate that China's central bank must have bought $70bn of foreign bonds last month in a frantic bid to hold down the currency.
We won't know for a while where the money went, but a big chunk must have gone into US Treasuries. So bear that in mind when you read the Xinhua claims that the US debt ceiling fight "has again left many nations' tremendous dollar assets in jeopardy and the international community highly agonised."
Or when it says:
A new world order should be put in place, according to which all nations, big or small, poor or rich, can have their key interests respected and protected on an equal footing. To that end, several corner stones should be laid to underpin a de-Americanised world.
Talk, talk, talk.
China's soaring reserves expose the truth. (And no, excess reserves are not a sign of strength, they are a sign of a deformed economy). Beijing is not in fact opening up its capital accounts and preparing to let the market decide the exchange rate.
The good news for China is that is no longer an emerging market in any meaningful sense. It was a safe haven during the great summer squall that hit India, Indonesia, Turkey, Brazil, South Africa, Ukraine, Serbia, et al. China did not suffer capital flight. It suffered a surge of very unwelcome capital inflows.
But there is a darker side to this. For all the talk of reform, China still refuses to give up its mercantilist trade policy. It is holding down the yuan to cling onto global market share and protect the wafer-thin margin of its exporters, not always successfully.
I have grave doubts about the new consensus view that China is roaring back. There is a high chance that this will fizzle out. You can see from Simon Ward's money data at Henderson Global Investors that China's money supply has rolled over:
Click to enlarge
Mr Ward's measure of six-month real M1 growth is an early warning for the economy, roughly six months ahead. So it points to a fresh slowdown over the late winter/early spring. Be prepared.
In any case, the recent burst of growth has been driven almost entirely by reverting to the bad old ways of top-down investment in heavy industry, and excess credit (yet again), as both the IMF and World Bank hinted in their latest reports.
The economic "efficiency" of debt has collapsed. Each extra yuan of loans now yields just 0.18 yuan of GDP growth. The credit cycle is played out. Debt has jumped from $9 trillion to $23 trillion in five years, reaching 200pc of GDP. Keeping it going is playing with fire. The experts in Beijing know exactly what this implies, but they can't easily stop it. Political vested interests are at play.
Zhiwei Zhang from Nomura has published a note, "China: Why the Economic Recovery is Unsustainable", citing seven reasons why the latest expansion is unhealthy and doomed to wilt like a failed souffle.
The one that struck me most was the finding in the IMF's Article IV report that China's full fiscal deficit (including local government) was 7.4pc of GDP last year. It was 9.7pc excluding land sales, which should be exclude because that sort of funding is a Ponzi scheme.
This is actually worse than the US, as you can see from the chart below:
This does not mean that the wheels will fall off the Chinese economy. What it does show is how far the Chinese growth model is living on borrowed time. All the low-hanging fruit has been picked.
It will be a much harder slog from now on.
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