China Soft Landing
Research for Online Investors

by John Dalt

7/06/11

China’s economy has led the world out of the credit crisis, expanding at a ten percent rate last year.  First quarter growth, for 2011, was recorded at 9.7%, and economists expect the second quarter eased to a 9.4% annualized rate.  These high rates of growth cannot be maintained without creating inflation, so China is trying to slow the growth of their economy through raising interest rates and tightening the availability of money.

This is what is referred to as a “soft landing.”  How do you slow an economy without risking a retreat into a recession (hard landing)?  The Peoples Bank of China (PBOC) raised interest rates 0.25% this morning.  June’s inflation rate will be released next week, and observers believe the PBOC’s actions today indicate the June numbers will show a jump in inflation.

Totalitarian governments have the luxury of knowing the “numbers” before anyone else. Inflation occurs when there is too much money chasing the available goods.  Chinese citizens are moving to the cities for jobs and want to improve their standard of living.  These workers spend their money on a place to live, and some creature comforts.

Real estate inflation has led to speculation.  Food inflation has been easy for average Chinese citizens to see.  When goods are increasing in price faster than interest rates paid for savings, why keep your money in savings?

Today’s interest rate increase also raises the interest paid on one-year deposits in banks to 3.5%  The one-year prime lending rate is set at 6.56%  The PBOC hopes to slow down the velocity of money leaving the banking system by offering higher interest rates on time deposits.  When interest rates are lower than the inflation rate, this is called a “negative” interest rate.

Negative explains that the customer is losing purchasing power because the interest rate paid on his time deposit is less than the rate of inflation.  China has raised the benchmark interest rate three times this year on top of two times last fall.  To slow down speculation in real estate, the PBOC has raised bank reserve requirements nine times since last fall.

Raising the reserve requirement for banks restricts the amount of money available to loan as they must keep a larger percentage in reserve.  Wages are expected to increase over 10% this year, with the economy expanding around 9% and Chinese industrial growth at 13%.

Mark Williams with Capital Economics believes this may be the last time China has to raise interest rates.  He believes their economy is decelerating and the growth rate will decline in the second half of this year.

The Chinese government wants to slow the economy’s growth but not kill it.  Small incremental moves to raise interest rates, and decrease the amount of money available for real estate loans are the tools they have employed.  We have not seen their target, but would suppose a growth in GDP of five to six percent will provide jobs for people moving to the cities without overheating the economy with inflation.

The market has traded even this morning but looks like it wants to consolidate gains from last week and move higher.  We are not convinced there won’t be a pullback in the near future and are playing our trades tight to the vest.  Watch your stops!

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

MarketToday Archive

Back to Top