China at the crossroads

An impressive run higher for global equity prices on Tuesday came to a crashing end on Wednesday in light of the ongoing measures from the People’s Bank of China as it strives to prevent its biggest banks from abusing easy lending conditions. 

Lax monetary conditions are of course a legacy from the days when the Chinese State stepped in to ensure that what the world had taken away courtesy of crashing American financial fortunes was replaced with home grown Chinese demand.

The problem that continues to face the People’s Bank of China is that its earlier encouragement of its banking system to lend, lend and then lend again has shown early signs of emergent bubbles in both real estate and share prices.

By putting its largest lenders through a series of undoubtedly rigorous capital adequacy standards it has ascertained in its infinite wisdom that the banking system should take a break from lending between now and the Chinese New Year in February.

The fallout from this series of calamities was pretty evident as equity prices weakened across the board. Optimism on Tuesday that markets were under valued and heading ever-higher was quickly reversed as equity indices swept to new lows for 2010. Some reports were keen to blame weakness in corporate earnings, while others were swift to blame a stronger dollar.

Gold prices lost the plot as the dollar fought a no-contest battle, while bond prices jumped to reflect an apparent loss of confidence in global economic recovery now that China has determined that borrowers should be made to feel they have both done something illicit and that they have missed the boat.

Investors unfortunately don’t have the benefit of hindsight when it comes to staving off short-sighted decisions to run away from such aberrations to what is a truly glorious bull run for stocks. And it’s at times like this when investors will be rewarded for seeing through short-term weakness.

Chinese demand for equities has in itself become a barometer for global recovery and has helped create a downward spiral in the dollar. And so the slightest notion that demand for minerals and metals is about to be displaced is manifesting itself in tow ways. First, its reducing commodity prices as natural buyers hold off while speculators conspire to drive prices down, albeit perhaps temporarily. Second, it’s boosting the value of the dollar – the veritable anti-commodity.

Yet the point is that Chinese real estate pundits and stock market speculators in the crosshairs of its central bank’s gun sight are the real target here. With Chinese manufacturing set to drive growth back above that magic double-digit rate for the final quarter of 2009, it’s hard to see recent monetary measures impacting this sector of the economy.    

At times like this, investors will likely be rewarded for making those longer term and against the shorter term trends.

John Bull
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