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Andrew Pyle

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China Sits Comfortably Behind the Steering Wheel

Posted: 07/13/2012 4:53 pm

We had some not so friendly news hit the wires this week regarding China. The world's largest consumer of things from the ground and largest sibling in the Asian region recorded slower-than-expected GDP growth for the second quarter: 7.6 per cent. This is the sixth straight quarter in which growth has decelerated and represents a half a per cent decline from the growth seen in Q1.

China, like most other major trading partners with Europe, has witnessed a significant impact on its exports to the troubled region, but has not pumped up its own domestic sector enough to compensate for the deterioration. Or, at least not yet. If we look at other economic metrics coming out of China, such as investment or retail sales, things do not look that bad. Housing activity has cooled, but this is what authorities wanted and engineered through tighter lending standards.

While most of us may view a 7.6 per cent rate of growth as more boom than gloom, it's important to recognize that China's threshold for civil pain resides at a much higher level than here in North America. In fact, most would argue that sub-five per cent growth in the country would be nothing short of a recession in relative terms. For that reason, Chinese authorities are going to do whatever it takes to ensure that the downward trajectory in growth does not continue any longer, lest those "recession-like" levels be flirted with.

The People's Bank of China (PBOC) has cut rates in each of the last two months and is fully expected to initiate further easing of monetary policy in the second half of the year to put a floor under growth. In addition, China has considerably more fiscal maneuvering room to stimulate growth than, say, the U.S. or Europe, where debt overload sends credit ratings downward.

This ability to control its economic future (near-term at least) has not been lost on the commodity markets. Since falling sharply from its highs north of 360 in spring 2011, the TR/J CRB index looks to have turned a corner this past June -- coinciding with the surprise action by the PBOC on rates.
The additional cut in rates in the first week of July has helped lift the index as well, though there is still a long way to go in this recovery. Ditto for one of the key commodities in the index -- crude oil -- which is still struggling to return to $100 per barrel, let alone the spring 2011 highs near $115.

For the recovery in commodity prices to continue, markets must be confident that stimulative actions taken by the Chinese will translate into improved growth and that could take a couple of quarters or more. Economic growth back in the nine to 10 per cent region could be achieved in 2013, depending on how aggressive Beijing gets with its policies, but this will also come down to what is happening to Europe and U.S. economic activity post-election. For now, I think investors need to treat the China commodity story differently than they have been looking at Europe and equities in general.

 
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