The Chinese decided last week that they weren’t going to be outdone by anybody.  If the Western world with all its governments and central Banks and World Banks and IMFs were willing to throw money at teetering businesses, then China would do the same.  “Money’s no object,” rose the cry from Beijing.  “Let the Yuan fly! We’ll show the Americans!  Anything you can do, we…”

And so it went.  The communists stole a play from the capitalists who stole a play from the communists.  But when the plan was revealed, it actually proved a doozy: the Chinese were pledging relatively more money to buttress local business than the Americans – or anyone else – had committed to date.  A full fifth of Chinese GDP would be spent over two years to impassion and arouse, er…excuse us, to stimulate the economy. 

And while there’s no question the Chinese are capable of massive economic auto-stimulation, why would they do it?

Boredom?

The chart below shows the incredible growth of Chinese foreign currency reserves

over the better part of the last decade.  The numbers speak for themselves: nearly two trillion dollars in reserves sloshing about in the belly can give one – even one so big as the People’s Republic – a whole lot of gas.  Consider this plan a Pepto-Bismol, then – a relief effort against the dyspepsia plaguing the world’s most populous nation.

The Real Reason

China’s is a booming economy.  According to the IMF they accounted for 27% of the world’s economic growth last year.  Sure, growth is slowing.  Poor SOB’s, it’s down to 9% growth in the latest quarter and will likely continue to slow somewhat even with the best of all possible scenarios: a short-lived recession in Western Europe and the U.S.

But so what?  Slowing growth isn’t negative growth.  And 9% growth is objectively awesome.  Why would they stimulate?

The answer is not so difficult.  The Chinese are aggressive.  They know all too well that they’re the next global star.  If they don’t account for a great percentage share of world GDP today, it’s just a matter of time.  And they’re willing to do anything and everything to get there – and to seize all the perquisites that they know will come in tow, i.e., a dominant military and far reaching diplomatic influence.  The waning of the American star comes lock-step with China’s rise.

The Year of the Panda

China’s 4 trillion Yuan (almost $600 billion U.S.) economic stimulus plan will not only sustain commodities prices into the near and mid-term, it will also provide moral and financial underpinning to the West in their war against recession and financial lockdown.

What does that mean?  It means that by stepping into the breach to shore up their own infrastructure and further enhance their own growth potential, China is in effect claiming leadership in the global effort to reflate.  This, in itself, is an astounding development – if it works.

And we’ve no doubt that it will.  The Chinese are gamblers, but they are not unaware of the processes developing around them – and they’re keenly aware of the tectonic financial shift that’s taking place that puts them literally in the center of the world of money.  When the Chinese are finished “saving the world” – as America did with the Marshall Plan after WWII – no one will doubt where economic power lies.

China is a country that has virtually no debt, and what little it does have is now viewed globally as safe as any modern Western country’s.  Take a look here:

This chart shows the cost of insuring the bonds of various nations the world over (as a function of CDS [Credit Default Swap] prices).  Essentially, the cheaper the insurance, the more trustworthy the issuer.  China places very respectably among nations whose political and financial stability is taken for granted today.  And in these days of economic crisis, she finds herself more creditworthy than fellow Asian dynamo (and capitalist) South Korea.

Tickling the Global Commodity Bull

China’s stimulus package will be spent on infrastructure projects – everything from housing and transportation to water and electricity upgrades, translating to thunderous demand for materials.  It was no surprise that commodity and mining stocks the world over were quick to jump on news of the package.  China consumes over half the world’s exported iron ore, 40% of its coking coal and over a third of its aluminum.  It’s an understatement to speak of the “disproportionate weight” of Chinese metals consumption.  The country essentially determines the world’s supply/demand equation for a number of industrial metals.

China’s ongoing, dynamic internal growth will spur the world economy in a material way.  And that, in turn, will maintain the demand for Chinese exports, the engine behind the so-called Chinese economic miracle.  Ongoing investment from Western sources should also be catalyzed by the latest move, which, incidentally, is being buttressed by a simultaneous loosening of bank credit and a new round of tax breaks.

Who is the teacher and who the student now?

There is a great irony in China offering the West a lesson in capitalism, but there’s little time to delve into these matters here.  The Chinese have proven themselves serious about maintaining their sky-high rates of growth.  And the health of Chinese capitalism is evident in its stock market, where Price/Earnings ratios have fallen dramatically this year, from 44.28 to 14.55 – a very low multiple for the Chinese market.

The United States, by contrast, saw an expansion in its P/E ratio, albeit small, from 20.11 to 20.54, even though U.S. markets lost 36.39% YTD (China’s market crumpled 64.37% in that time).

Why the difference?  Earnings (E) in the U.S. market fell at a greater rate than price (P), while in China, price contraction was preeminent.  For the U.S. this is not good news.

One also wonders why American stocks would have an aggregate multiple of 20, while China’s are priced at 14.55x.  We always thought that emerging markets experiencing higher rates of growth had higher multiples associated with them.

Hmm…

Look to China and commodities as investment themes once again driving markets through 2009.

Cheers,

Matt McAbby
Analyst, Oxbury Research