July 01, 2010

Red Herring

The disadvantages of reacting to partial sound bites from an authoritarian establishment pursuing single-minded geopolitical agendas couldn’t have been clearer: the world’s markets went into a tizzy when the Chinese central bank announced it would manage the Yuan more flexibly in future. Analysts around the world, no doubt fortified by advanced spreadsheets and financial models on their computers, told us, in great detail, the impact a presumably appreciating Yuan would have on currencies, commodities, global trade, stock markets and on the cost of my cat’s pet food. The Chinese economy will cool down, we were told, as their export led economy slowed on the back of a stronger Yuan. Commodity prices and trade would be hit as Chinese demand fell. Shipping would suffer; dry cargo rates plunged as a result.

A day later, when the same Chinese central bank announced that it would maintain a stable exchange rate, and did not anticipate any major change in the Yuan’s value, all those analysts were silent. Probably exhausted after a high adrenalin 24 hours of calculations, I think.

As always, what the Chinese have done is outsmarted most everybody else while pursuing a straight-line agenda. Some of us, in India and elsewhere, used to the cacophony and chaos of capitalist democracies, do not appreciate the fact that the Chinese ship may steer a few degrees this way and that, but its long-term course is as straight as an arrow. They always, without exception, have an eye on the big picture being painted and add a brushstroke or two with every announcement.

My read of the statements is this: One, the timing of the announcement, a week before the G-20 summit in Toronto, was meant to deflect criticism that the Chinese currency was artificially kept undervalued at everybody else’s expense. The statement did just that: it also allowed the US and President Obama, critical of Chinese policy, a rare face saving moment. Two, the Chinese have been trying, over the last many weeks, to cool down their overheated real estate markets, which some call the biggest real estate bubble in the world today. A perceived slowdown may help in this control. Three, I wouldn’t hold my breath anticipating a Yuan spike anytime soon, because an appreciation of their currency is bound to jeopardise China’s export-led economy. Given labour unrest, an open secret in the country today, the Chinese can ill afford to have people losing jobs; that may cause disgruntlement and threaten their very foundation; a totalitarian system so far in absolute control. Four, jingoistic American thinking may suggest- as it does with outsourcing to India- that an appreciating Yuan will mean manufacturing jobs coming back to the US. The fact is, however, that these jobs are more likely to go to other developing countries so far made uncompetitive by the Yuan’s artificial value, and will not be ‘coming home’ to the US anytime soon. And five, China owns more around 1.6 trillion dollars of US securities, and is buying more dollar denominated debt every week; it will not want to see its investments depreciating unless there is a political or military advantage that justifies the loss.

The Chinese Yuan affair is a red herring, in my view. The dragon’s economy may well cool down, but the reason for this will not be the Yuan’s presumed rising value; The reality is that Chinese exports are much more likely to be hit, simply, by a drop in demand from the US and Europe. This will obviously have a direct and negative impact on shipping.

The UK, after Greece and Spain, was forced to announce ‘austerity measures’ last week. The Euro zone is in a sovereign debt crisis. Consumption will come down; it has to. The levels of debt for the US and UK are staggering and at unprecedented levels; worse, the City of London and North Sea oil, two of the UK’s largest earners, are running out of time and gas. The US, on the other hand, is being bled by two wars it can no longer afford, and, while there may well be a spike in tanker demand after the Deep Water Horizon catastrophe (although a US judge has overturned Obama’s moratorium on drilling even as I write this), expecting large scale demand to pick up from that country very quickly may be futile. The US Federal Reserve indicated so when he announced last week that events in Europe may slow US recovery.

The Yuan’s assumed appreciation is, in any case, not going to solve Europe’s problems or the ones in the US; their economies are hardly going to start growing again just because the Chinese central bank made a statement or two on exchange rates- or even if the Yuan appreciated slightly. As for China, a rising Yuan is not the issue they face. Their issue is that two of China’s largest markets – the EU and the US- are struggling and therefore will buy less. One doesn’t need a spreadsheet to work out the impact on China of this slowdown.

Shipping, with its added tonnage supply overhang problems, needs to be cautious today- perhaps even more so. Governments pumping in trillions around the world may have averted catastrophe in recent times, but equally importantly, this artificiality has hidden the greater problem from obvious view. The price for the excesses committed during the boom years has still not been paid; in fact, it may have been deepened or postponed by the bailouts. The consequences of decades of countries living beyond their means are still being listed. Countries are being bailed out in the developed world.

Regional markets aside, to think that broad shipping demand will shoot through the roof in all this may be very, very wishful. One does not need a spreadsheet to know that either.